By Josie Cox

European markets slipped Monday as tensions between Russia and the West intensified and the Middle East endured the deadliest day of fighting between Israelis and Palestinians since the most recent conflict began.The Stoxx Europe 600 was trading 0.4% lower by early afternoon, with losses extending across all the continent's main bourses. In currency markets, the ruble fell against both the euro and U.S. dollar, while Russia's Micex and the dollar-traded RTS Index declined 2.6% and 2.3% respectively, hitting fresh two-month lows. Futures don't always accurately predict moves at the open, but the S&P 500 in the U.S. was indicated dwindling 0.2% after the bell.

Over the weekend, the U.S. leveled its most explicit allegations yet of Russia's involvement in the downing of a Malaysia Airlines flight last Thursday that left 298 people dead, and subsequent efforts to conceal evidence.

European leaders threatened broad new sanctions against Moscow, departing from their initially muted reaction and marking a turning point in the standoff between the West and the Kremlin.

Also weighing on market sentiment, unrest flared across the Middle East over the weekend. Israel said 13 soldiers were killed and Gaza officials said 96 Palestinians were killed on Sunday, including 60 in the Gaza City neighborhood of Shajaiyeh where the battle of the tunnels was fought.

Initially markets showed a muted reaction to the developments Monday, with strategists at BNP Paribas noting that the tensions between Russia and the West will likely exert greater pressure on President Vladimir Putin to adopt a conciliatory approach, but later a sense of apprehension spread.

Deutsche Bank strategist Jim Reid described the situation as extremely dangerous and delicate. He added that despite the understandable conclusion that the market may be reaching, that diplomacy is the only sensible outcome, the risk of destabilization cannot be discounted.

"This story still has a long way to run," he said.

Alberto Gallo, a strategist at Royal Bank of Scotland Group, said that investors may be puttingtoo much faith in central banks to rein in tensions and stabilize markets.

"Central banks may manage to overshadow geopolitical tensions for now and the near future," he wrote in a note, adding that emerging market bonds particularly, could become particularly exposed to risks.

Talib Sheikh, a manager of the J.P. Morgan multi-asset income fund, which is part of a multi-asset platform with over $25 billion under management, said that volatility was already edging higher in the wake of this, and that we could see some forced unwinding of risk-on positioning, if it continues to do so.

Typical safe-harbor assets such as gold and U.S. government bonds, having rallied in the direct aftermath of the Malaysia Airlines plane crash, were trading moderately stronger Monday, too.

Gold added 0.6% to hit $1,317.10 an ounce while the 10-year U.S. Treasury yield stood at 2.48%, down from around 2.56% before the crash on Thursday. Yieldsfall as bond prices rise.

UBS economist Paul Donovan said that if tensions in Russia and Gaza escalate further, energy prices would be the first to react. Brent crude, however, was trading little changed on the day, at $107.10 a barrel.

Elsewhere, the corporate earnings season moved into focus Monday.

Shares in Julius Baer Group AG led the pan-European index, adding more than 8%, after the Swiss bank said that assets under management rose 8% in the first half of this year and announced plans to take over Israeli lender Bank Leumi's Swiss private banking operation.

In the U.K., engineer contractor Babcock International Group PLC rose to the top of the FTSE 100 after the group said that its order book for the coming year had risen to GBP13.5 billion ($23.1 billion).

Shares in retailer Tesco PLC advanced too, after the U.K.'s biggest retailer said Chief Executive Philip Clarke would leave the company in October to be replaced by Unilever executive Dave Lewis. That news offset Tesco's latest profit warning.

Write to Josie Cox at josie.cox@wsj.com

(END) Dow Jones Newswires

July 21, 2014 09:37 ET (13:37 GMT)

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