LONDON — Markets plunged Tuesday on fears that Europe's plan to save the euro was unraveling after Greece's leader unexpectedly called a referendum on the country's latest rescue package.
Markets are worried Greek Prime Minister George Papandreou wouldn't be able to pull off a victory — assuming that his government holds together.
Papandreou saw his parliamentary majority cut to 2 seats on Tuesday after one lawmaker quit the ruling party, while another two called for him to resign. At least five other Socialist lawmakers last month called for the formation of a cross-party, national unity government.
The implications for Greece and Europe of a "no" vote in a referendum are massive — it would imperil Greece's membership of the euro and could cause a messy debt default, which would hurt banks and roil global markets.
"Talk about your all-time bonehead moves," said Benjamin Reitzes, an analyst at BMO Capital Markets. "It would reintroduce the risk that Greece could face a disorderly default and potentially be forced to leave the euro."
Papandreou stunned markets and even his own citizens and fellow eurozone partners by announcing late Monday that a vote will be held. A confidence vote in the Socialist government will also take place at the end of this week.
The news dealt a huge blow to the European debt deal, in which confidence had already been fading.
On Monday, sentiment was already turning sour after U.S. brokerage firm MF Global filed for bankruptcy amid reports that it had bought too much bad European debt and fears over the public finances of Italy, the eurozone's third-largest economy. Italy's debts dwarf the €1 trillion ($1.4 trillion) that Europe's bailout fund will have at its disposal if last week's commitments are delivered.
"The 6-8 percent falls over two days have now effectively given back all the gains from the post Brussels meeting rally," said Louise Cooper, markets analyst at BGC Partners.
The plan presented last week by eurozone leaders was intended to be Europe's comprehensive solution to a debt crisis that's already seen three countries, including Greece, bailed out.
The three-pronged strategy of boosting the bailout fund, getting private creditors to take a bigger hit on their Greek debt holdings and forcing the banks to raise more capital was largely viewed favorably by the markets, although details need to be ironed out.
In Europe, the FTSE 100 index of leading British shares fell 2.7 percent to 5,393, while Germany's DAX slid 4.7 percent to 5,857. The CAC-40 in France was 5 percent lower at 3,081. Unsurprisingly, Greek shares led the retreat with the main exchange in Athens down 6.9 percent.
Italy's stock market fared even worse, trading 6.3 percent lower as its borrowing costs spiked in the bond markets. The yield on Italy's 10-year bonds was up another 0.21 of a percentage point to 6.20 percent, having earlier risen to 6.30 percent. Despite the modest retracement from earlier highs, Italy's yield is not far below the 7 percent level many investors think is unsustainable.
The euro was 1.4 percent lower at $1.3655.
Wall Street suffered a big retreat, too — the Dow Jones industrial average was down 2.5 percent at 11,640 while the broader Standard & Poor's 500 index slid 2.9 percent to 1,218.
As well as the events in Europe, investors have a raft of economic news to digest this week, culminating in Friday's monthly U.S. jobs report.
A weak U.S. manufacturing survey from the Institute for Supply Management added to market fears over the state of the U.S. economy. Its main index fell to 50.8 in October from the previous month's 51.6, meaning it's only just above the 50 threshold that indicates expansion.
Alan Ruskin, an analyst at Deutsche Bank, said the survey was consistent with "the slow growth scenario, rather than a recession outlook, but all of this goes with the proviso that there is not a larger external shock."
The Federal Reserve and the European Central Bank also meet to decide on their monetary policies this week. The new ECB chief, Mario Draghi, will hold his first meeting and press conference Thursday. Investors will be looking for signs that the ECB is considering cutting interest rates and that it will continue its program of buying the bonds of troubled eurozone nations, especially Italy and Spain.
Earlier in Asia, stocks fell sharply.
Japan's Nikkei 225 index retreated 1.7 percent to close at 8,835.53. Hong Kong's Hang Seng lost 2.5 percent to 19,369.96 and Australia's S&P/ASX 200 shed 1.5 percent to 4,232.90. Benchmarks in Singapore, India, Indonesia and Thailand were also down.
South Korea's Kospi gained marginally to 1,909.63 and China's Shanghai Composite Index added 0.1 percent to 2,470.02.
Oil prices tracked equities sharply lower. Benchmark crude for December delivery was down $2.33 at $90.86 a barrel in electronic trading on the New York Mercantile Exchange.
Pamela Sampson in Bangkok contributed to this report.