BERLIN/ROME (Reuters) – Germany may widen its ban on speculative financial trades to cover all shares, a leaked government document showed yesterday, as fears about the euro zone's debt crisis sent stocks and the euro plunging further.

The Finance Ministry draft said planned measures aimed at stabilising financial markets would include a "ban on naked short selling of shares, including derivatives referring thereto".

Berlin stunned markets last week, drawing widespread criticism from its global partners, by unilaterally suspending naked short selling in euro sovereign bonds and credit default swaps as well as stocks in some financial companies.

Investor worries that the euro zone debt crisis may turn into a banking crisis drove European stocks and the euro sharply down yesterday while safe-haven German bonds hit a record high.

Highly indebted Italy was the latest euro zone country set to announce a two-year austerity plan worth 26 billion euros ($32 billion) despite concern that Europe-wide retrenchment may harm global economic growth.

The Italian cuts will hit public sector pay and recruitment, health spending and road building, and mean later retirement for some state workers and less funding for local government.

The pan-European stock index fell by as much as 3.4 percent at one point to a nine-month low, with banking stocks hardest hit on jitters over the Bank of Spain's weekend takeover of a small savings bank, CajaSur, after a failed merger with another regional lender.

US stock futures pointed to a sharply lower open on Wall Street.

Spanish analysts said savings bank consolidation has been long planned as part of efforts to rationalise the sector.

However, markets worry that more troubles in southern Europe will have knock-on effects for larger euro zone banks, which are owed billions by public and private borrowers in the region. There are also worries about a lack of resolution for banks' bad debts in the euro zone.

"The big challenge is to prevent the vicious circle, that means for example the crisis of the public sector turning into a banking crisis," European Central Bank governing council member Ewald Nowotny told a Brussels conference.

The dollar, seen as a safe haven from Europe's debt worries, gained one percent against the euro and sterling. The euro briefly traded below $1.22, erasing most of the recovery from last week's four-year low.

The global financial system is showing signs of increased stress, though still well short of the panic that followed the collapse of investment bank Lehman Brothers in September 2008.

The two-year US bond-swap spread, a key gauge of financial system stress, rose to fresh one year highs near 60 basis points, up from 51 bps on Monday. It reached 160 bps in the weeks after the Lehman crash.

Shares in Europe and Asia were dragged lower by fears that austerity measures being announced by European governments that piled up debt and deficits during the financial crisis will shackle a global economic recovery.

"There is indeed a risk that, under market pressure, some countries overdo austerity," Olivier Blanchard, chief economist of the International Monetary Fund, said in a newspaper interview. "That would be a mistake."

European Union officials played down the risk of public spending cuts and revenue increases damaging economic recovery.

European Council President Herman Van Rompuy told a Brussels Economic Forum: "In the short term, the acceleration of fiscal consolidation will hamper growth in the euro zone as a whole only marginally."

European Economic and Monetary Affairs Commissioner Olli Rehn urged EU governments to combine "smart" budget cuts with structural reforms such as freeing up labour markets to return the euro zone's medium-term growth potential to two percent.

"The critical question is whether the real economic recovery can sustain the renewed financial turbulence," Rehn told the same conference.

A month-long selloff has routed global stocks as even a $1 trillion pledge from European leaders was not enough to calm fears that Greece's debt woes would spread to other deeply indebted nations, particularly in southern Europe.

Concern at increasingly fierce rhetoric between North and South Korea over the sinking of a South Korean warship added to stock market nerves in Asia.

White House economic adviser Lawrence Summers also listed Europe's struggle to contain Greece's debt crisis as one several potential troubles facing the US economy.

Banking sources said some of Europe's banks are looking at using government guarantees again to help raise money from the corporate bond markets which have been shut for more than a month by the sovereign debt crisis.

If markets stabilise, strong banks from France, Germany and Scandinavia — Europe's core — are expected to try to start issuing bonds again, but banks from southern Europe are likely to need support because of mounting investor concerns over sovereign risk.

"Government guarantees are under consideration from a number of quarters more actively now than a few months ago," said a senior debt capital markets banker from a US bank.