By Ankika Biswas, Johann M Cherian and Ozan Ergenay
(Reuters) -A sell-off in defence stocks dragged Europe's benchmark stock index lower on Tuesday, while investors braced for this week's crucial U.S. inflation data and the European Central Bank's monetary policy decision.
The pan-European STOXX 600 index closed 0.6% lower, a day after notching its strongest session in nearly three weeks. Benchmark indexes in Germany, France and Italy lost between 0.9% and 1.3%.
Defence-related stocks like Sweden's SAAB, Italy's Leonardo, Germany's Rheinmetall and France's Thales were among the top laggards on the STOXX 600, down between 4.9% and 9.8%.
A gauge of European aerospace and defence stocks slumped 3.7%, logging its steepest one-day slide in over a year.
Traders turned nervous about the sector's record-breaking run fuelled by rising military spending after Russia's invasion of Ukraine in February 2022, with analysts noting potentially stretched valuations.
Caution prevailed ahead of the U.S. inflation report on Wednesday and the ECB's policy decision on Thursday which could shed light on when major central banks might start cutting interest rates this year.
"Confidence in getting closer to rate cuts is rising in our view, but still data dependent and insufficient for action," wrote analysts at Bank of America.
"The 'meeting-by-meeting' approach means we shouldn't expect guidance on the pace and depth of the cutting cycle."
Euro zone bank shares dropped 1% after an ECB survey showed lenders lowered the bar on first-quarter mortgage approvals for the first time in over two years, but demand for credit kept falling as borrowing costs remained high in a stagnant economy.
Daimler (OTC:MBGAF) Truck Group lost 4% after the company reported a 13% drop in first-quarter sales.
Biomerieux jumped 8.6% after the French diagnostics specialist published first-quarter organic growth above consensus estimates, and presented a new five-year strategic plan.
KGHM advanced 8.7% following BoFA Securities' double upgrade on the miner.
BP (NYSE:BP) rose 1.3% after the UK oil giant forecast a rise in first-quarter upstream production of oil and gas as well as low-carbon energy from the previous three months.
Italian shipbuilder Fincantieri climbed 3.9% after finalising a deal with Norwegian Cruise Line (NYSE:NCLH) to supply four new cruise ships.
The basic resources sector bucked the broader trend to gain 1.4%, rising for the second consecutive day to its highest level since the start of the year.
Meanwhile, the Italian government cut its growth forecast for this year and next and said public debt was set to rise.