* FTSEurofirst 300 down 0.8 percent * Euro zone banking index tests major support level * Credit Suisse ups 'underweight' on European shares By Tricia Wright LONDON, March 27 (Reuters) - European shares fell sharply on Wednesday, dragged lower by banks after soft demand at an Italian debt auction rattled investors already concerned about the implications of the bailout in Cyprus. Italy paid more to borrow over five years than it has since October as lack of progress in forming a new government hit demand. By 1231 GMT the FTSEurofirst 300 was down 0.8 percent at 1,179.34, well off an earlier high of 1,193.63 in a choppy session. The first fall in euro zone economic confidence after four months of gains darkened the mood further in a market already concerned a rescue plan for Cyprus might be used as a template for other euro zone economies requiring bailouts. The euro zone banking index, off 2.5 percent at 100.74 points, tested a major support level at around 101 points, representing lows hit in September, October and November. "I think this (choppy trading) could continue this week, and potentially next week, and then the market will focus again on something (other than Cyprus)," Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets, said. "You're still looking at some sort of an economic recovery going on worldwide... and central banks are still very much there to inject liquidity in the system, so I think these two drivers will once again pick up the market." UK lender Lloyds Banking Group bucked the weak trend in the banking sector. It was the second-top FTSEurofirst 300 riser, gaining 1.6 percent after a Bank of England committee said it must raise a further 25 billion pounds ($37.9 billion) to help absorb possible future losses, at the low end of the forecast range. EUROPE TO LAG MARKET? Others were less optimistic on European equities. Patrick Moonen, a senior strategist at ING recently downgraded Europe to "underweight" relative to the U.S. market, citing deepening economic malaise in the region. "We think (European equities) will lag the rest of the world (because of) economic data, also earnings momentum which is clearly weaker in Europe relative to, for example, the U.S.," he said. Similarly, Credit Suisse equity strategists increased their 'underweight' stance on continental European shares while remaining 'overweight' on equities as a global asset class. They believe European equities are not cheap enough given the region's euro zone debt crisis and weak economic backdrop. "Europe only looks, we think, clearly cheap on trend earnings using the Shiller methodology, but the current trend rate of real EPS growth (6 percent) looks unsustainable to us: if we put in a more realistic trend growth rate (3 percent), then this 'cheap' valuation disappears," they wrote in a note.