Question marks over EU progress triggers profit taking ahead of EU Summit

The FTSE 100 and peer EU indices saw a sharp reversal from gains of near 1% within the first hour of trading, to lose around 0.4% going into the close, weighed down by weakness in financial stocks.

We have started to hear the first real signs of tension between EU leaders and politicians as they prepare to descend upon Brussels for what is fast being labelled as make or break time for the eurozone.

Earlier in the morning, a senior German figure told reporters that last week’s progress that saw France and Germany agree fresh measures for a new EU Treaty had lost momentum and they were feeling more pessimistic this week about making significant progress.

Whilst there is every chance that this could simply be a PR tactic to downgrade market expectations after a week of optimism building, investors are not taking any chances.

This has put a bit of a dampener on the optimism that has driven stock markets higher over the past week and a half and has convinced many investors to start locking in their profits in case of a bad disappointment from Brussels if EU leaders fail to agree on fresh measures to contain the crisis.

Indeed, much of the optimsim we have seen over the past week has been triggered by expectations of a greater role in the crisis of the ECB, though with that role likely to be dictated by progress being made amongst EU leaders to agree a fiscal union, eyes remain firmly on Brussels.

The profit taking escalated into the afternoon session after details of the Franco-German proposal to Herman Van Rompuy, the European Council President, emerged showing that the two nations want to include within the new EU framework a common corporate tax base and the much maligned financial transaction tax. This weighed on banking stocks and trading firms in afternoon trade.

With so much at stake and early optimism starting to wane, it’s only natural that investors downsize the amount of risk they have built up over the past week.

From the lows of November 25 to today’s highs, the FTSE 100 has rallied 11%, which is a big rally in such a short space of time. Has market confidence been so high to warrant a rally of this amount? Perhaps not and with cracks starting to appear in the EU’s thinly layered unity ahead of tomorrow’s start of the EU Summit, investors have moved to protect their profits.

We are entering into the business end of the trading year now with so much at stake over the next 48 hours with the EU Summit in Brussels. The next 48 hours will likely prove crucial in either giving investors enough confidence to believe that the eurozone can be saved or not. We will see over the course of events in Brussels whether EU leaders can deliver the sort of solidarity and fiscal changes the market needs to see to contain the debt crisis and set stocks up for a Christmas rally.

There is every chance that with the stakes so high and all investor attention towards developments in Brussels, we could see a very edgy and nervy market over the course of Thursday and Friday’s sessions, with prices reacting to all news, rumour and speculation out of Belgium.

Any surprises from the ECB’s rate decision at lunch time tomorrow could also see sharp moves in stock markets, where Mario Draghi is expected to cut rates by 25 basis points yet again and could signal fresh liquidity support.

Banks and insurers were the key drags on the FTSE 100 today, with both sectors losing between 0.7% and 1% on the day. Royal Bank of Scotland, Man Group and Kazakhmys all fell around 2% as a result, whilst ICAP was the worst performing stock, losing 5%.