By John Geddie
LONDON (Reuters) - European stocks fell on Wednesday while nervous investors took refuge in high-rated bonds on reports of a build-up of Russian troops near the border with Ukraine.
The euro came under pressure, trading at nine-month low against the dollar amid threats of retaliatory Russian sanctions against the European Union, and signs the crisis in Ukraine was hitting Europe's biggest economy Germany.
German industrial orders slid in June at their steepest rate since September 2011, with the economy ministry saying political tensions had probably led to more cautious ordering.
"We are getting closer to a situation where we really have an escalation of the conflict...sanctions being stepped up, and things moving out of control," said Elwin de Groot, senior market economist at Rabobank.
European stocks fell 1.3 percent - the biggest one day fall in nearly a month - while MSCI's world equity index was down 0.5 percent. Dollar-traded Russian stocks hit a three-month low.
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German 10-year bond yields fell 3 basis points to 1.15 percent. Yields on lower-rated peripheral bonds rose, extending losses after data showed the bloc's third largest economy Italy had slipped back into recession.
Portuguese bonds were the worst hit, rising 6 bps to 3.79 percent. The country's main bourse gave up 2.2 percent to hit its lowest level in over a year, with financial stocks hit by concerns over fallout from a rescue plan for ailing Banco Espirito Santo.
'SABRE-RATTLING'
As Kiev pressed on with an offensive against pro-Moscow separatists in eastern Ukraine, Polish Prime Minister Donald Tusk said the threat of direct Russian intervention in the neighbouring country had risen.
"The situation in Ukraine is not adding any positive sentiment, as the (Ukrainian) government is indicating its intentions to launch an assault on Donetsk; and there is a build-up of Russian troops along the border," analysts at Alfa Bank in Moscow said in a note.
Russian Prime Minister Dmitry Medvedev also threatened on Tuesday to retaliate for the grounding of a subsidiary of national airline Aeroflot because of EU sanctions, with a newspaper reporting that European flights to Asia over Siberia could be banned.
"The latest catalyst seems to be this sabre-rattling at the border, and the market just has no upward momentum. This talk of tit-for-tat sanctions is also adding to the risk-off tone," Jeremy Batstone-Carr, analyst at Charles Stanley, said.
Risk aversion and upbeat U.S. economic data, which included a spike in service-sector activity to a nine-year peak and a uptick in factory orders, helped lift the dollar to an 11-month high against a basket of major currencies.
The dollar index rose to as high as 81.637, its highest level since last September, before falling back to 81.582.
The Chinese yuan hit a 4-1/2-month high on Wednesday, as other emerging Asian currencies slid, indicating that traders may be preparing the ground for robust second half gains.
The New Zealand dollar skidded to two-month lows after milk prices fell again at an auction held by Fonterra Co-operative Group, the world's biggest dairy exporter.
Oil prices remained under pressure as plentiful supplies in Europe and North America outweighed fears that violence in the Middle East and North Africa could disrupt production.
Brent crude edged up 15 cents on Wednesday to $104.77, but that followed its weakest close since November 2013. U.S. crude was 21 cents firmer at $97.59, following its lowest settlement since early February.
Gold failed to get much of a lift from safe-haven flows and idled at $1,289.00 an ounce.
(Editing by John Stonestreet)