By Mike Bird

European stocks dropped in morning trading Tuesday, after a four-day break, and volatility returned to currency markets as British Prime Minister Theresa May called a surprise general election.

The Stoxx Europe 600 index fell by 0.9% in midmorning trading, led by a 1.3% drop in France's CAC 40 index.

U.S. equity futures fell slightly, with contracts on the S&P 500 down 0.17% and those on the Dow Jones Industrial Average down 0.13%.

The pound fell sharply against the dollar and euro on the news that U.K. Prime Minister Theresa May would make an unexpected statement at11:15 a.m. London time, down to as low as EUR1.175 to $1.252.

After Ms. May announced that a surprise election would be held on June 8, sterling jumped higher, rising to $1.257 and EUR1.18.

Yields on the U.K's 10-year government bonds also tumbled ahead of the statement, reaching 1% for the first time since October.

U.S. equity futures fell, with contracts on the S&P 500 and the Dow Jones Industrial Average each down 0.4%.

U.S. stocks had posted their biggest gains Monday since the beginning of March, with the S&P 500 up 0.9%.

Political tremors elsewhere in Europe also reached foreign-exchange markets.

The first round of the French election will be held Sunday. Two candidates go forward into the second round on May 7 and the race has become a four-way split since the rise of left-wing firebrand Jean-Luc Mélenchon.

"It's nervousness as opposed to concern," said Kit Juckes, global head of foreign-exchangestrategy at Société Générale SA. "You have four candidates within 5% of each other, so nervousness would be a sensible reaction."

The nerves stem from the possibility that either Mr. Mélenchon or far-right candidate Marine Le Pen, who has promised a referendum on France's membership of the European Union, could outperform and emerge victorious after the second round.

The euro was up 0.09% against the U.S. dollar at $1.065 in morning trading, but stress relating to the French election were clear in other parts of the currency market.

One month euro-dollar risk reversals, which measure the cost to investors of protecting against a sudden decline in the euro, touched minus 4.3, the most extreme reading since at least 2011. More negative numbers suggest investors are paying increasing amounts to hedge against a currency decline.

"The polls still look too close for comfort," said Emily Nicol, economist at Daiwa Capital Markets. "For example, one Ifop poll published Tuesday puts Macron and Le Pen each on 23%, just 3 percentage points ahead of Fillon and the far-left Mélenchon."

The dollar was roughly flat against a basket of other international currencies, with The Wall Street Journal Dollar Index up 0.02%.

The spread between French and German 10-year government bond yields--another indicator of market worries--ranged from 0.767 percentage point as markets opened to 0.172 percentage point in midmorning trading. Late in 2016, before the French election loomed, the spread was as little as 0.22 percentage point.

In Asia, the Shanghai Composite Index closed down 0.79% after dropping in late trading. The index fell by 1.6% across Friday and Monday, in its largest two-session drop since December.

Steel and iron-ore futures--which hit four-year highs in March--fell sharply in China, where iron-ore imports and steel production have outpaced physical demand and where the government is trying to cool a housing bubble. Iron ore futures have dropped by around a third in price since mid-March.

In Hong Kong, the Hang Seng also closed down, by 1.39%.

Kenan Machado

contributed to this article.

Write to Mike Bird at Mike.Bird@wsj.com

(END) Dow Jones Newswires

April 18, 2017 06:53 ET (10:53 GMT)

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