European shares down on cliff fears

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London - European shares drifted lower in thin trade on Friday, showing little faith among investors that new talks can avert at least some version of a New Year budget crunch in the United States.

By 1122 GMT, the FTSEurofirst 300 was down 3.39 points, or 0.3 percent at 1,134.21, while the euro zone blue chip index fell 0.4 percent.

Trading volumes for euro zone indexes were light, down by a about third compared with levels a year ago with December on track to be the quietest month in six years, according to Thomson Reuters Eikon data.

Meanwhile, volatility - a crude gauge of investor fear - held near five-month highs.

The market took heart on Thursday from a move to reconvene Congress on Sunday Dec. 30, but all of the evidence from the past fortnight suggests that Republicans and Democrats are as far apart as ever.

“Any deal now will be no more than a sticking plaster on a festering wound,” Rebecca O'Keeffe, Head of Investment at Interactive Investor,said.

To compound problems, the U.S. will hit its statutory debt ceiling on Dec. 31, which will put the world's biggest economy's credit rating under threat.

Still, the FTSEurofirst 300 is set to post a gain of 14 percent for 2012 while the euro zone's blue chip Euro STOXX 50 index has risen 15 percent.

Both indexes are enjoying their best annual performance since the sharp bounce of 2009 fuelled by unparalleled support for the global economy by central banks and expectations of a deal being struck in the U.S.

While worries that the “fiscal cliff” of tax hikes and spending cuts could drag the U.S. economy into recession do not appear to be fully reflected in the cash market, investors are snapping up downside protection on equities in the final trading days of 2012, taking the put/call ratio on EuroSTOXX 50 to its highest level in a year.

“Global equity markets are remarkably robust. Given that the market does not appear to have priced in failure (in the U.S. to agree a deal), it does suggest that investor optimism may be misplaced,” O'Keeffe said.

Investment Bank Morgan Stanley said in a note that a fiscal cliff resolution is looking less likely before year-end but many analysts and market players have argued that authorities will muddle through and wind up easing the impact on the economy in coming weeks even if a deal is not reached.

There were few sectors in positive territory but those that were more of a defensive nature - companies whose products remain in demand even when the economy is weak - with healthcare and household products both slightly higher.

Auto-related stocks were the top gainers led mainly by Porsche whose shares surged 6 percent after it won a dismissal of a U.S. lawsuit by 26 hedge funds, one of several legal actions over its purchase of shares in Volkswagen , Europe's largest carmaker. -Reuters