* Soft demand at Italy debt auction sparks concern
* Cliffs Natural shares plunge after downgrade
* U.S. February pending home sales index fell 0.4 pct
* Dow off 0.3 pct; S&P 500 off 0.2 pct; Nasdaq off 0.2 pct
By Chuck Mikolajczak
NEW YORK, March 27 U.S. stocks dipped on Wednesday as soft demand at an Italian debt auction kept concerns about the financial stability of the euro zone at the center of investor focus.
The stalemate over the formation of a new government in Italy and the fiscal upheaval in Cyprus were reflected in a rise in Italian bond yields, with the five-year debt costs at the highest level since October.
But equities pared earlier losses after a Greek newspaper reported Cyprus plans to ban cashing checks and limit the amount of cash that can be taken out of the country under a series of measures to avert a run on the country's crippled banks.
"Markets sold off early. Of course, it's focused like a laser on Italy and Cyprus, and none of the headlines coming out of that part of the world are really engendering a great deal of confidence in a positive outcome," said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey.
"Yes, we've rallied off the intraday lows, but with no volume, and frankly we've done that without the banks opening in Cyprus," Kenny added.
The PHLX Europe sector index declined 1.3 percent.
Cypriot banks are due to reopen on Thursday. The chief executive of the Bank of Cyprus, the country's largest commercial lender, said he had been dismissed by the Central Bank.
The Dow Jones industrial average dropped 40.67 points, or 0.28 percent, to 14,518.98. The Standard & Poor's 500 Index shed 3.68 points, or 0.24 percent, to 1,560.09. The Nasdaq Composite Index lost 6.93 points, or 0.21 percent, to 3,245.55.
Still, the S&P 500 remains about 5 points away from its all-time closing high of 1,565.15. The index has been unable to break through that milestone in recent sessions, including Tuesday's gains that left the benchmark within 2 points of the historic level set on Oct. 9, 2007.
As more attempts to break the mark fall short, the likelihood of a sharper pullback - that many analysts have been anticipating - grows.
Boeing was the biggest drag on the Dow, off 0.9 percent at $85.84 as the company faces a temporary ban on some of the long-distance, trans-ocean journeys for its 787 Dreamliner while it works to regain permission for the resumption of flights.
Cliffs Natural Resources Inc shares lost 15.3 percent to $18.15 and ranked as the S&P 500's worst performer after Morgan Stanley downgraded the miner's stock and Credit Suisse slashed its price target, citing difficulties from a surplus of iron ore pellets in the Great Lakes region.
Data showed contracts to buy previously owned U.S. homes fell in February, held back by a shortage of properties, but there was little to suggest that the housing market recovery was stalling. The National Association of Realtors said its U.S. Pending Home Sales Index slipped 0.4 percent in February. Economists had expected a decline of 0.2 percent.