GLOBAL MARKETS-US, Europe stocks slump before stress tests

                                
 * U.S., European stocks drop ahead of stress test results
                                
 * Bond prices decline on weak 30-year Treasury auction
                                
 * Bank stocks down more than 3.5 percent after huge run-up
 (Updates to U.S. market close)
                                
 By Jennifer Ablan and David Gaffen
                                
 NEW YORK, May 7 (Reuters) - World stock markets dropped as
investors readied for the release of government stress tests on
the 19 largest U.S. financial institutions after the close on
Thursday.
                                
 With stocks having rallied steadily for about two months,
fund managers reduced holdings even though leaked reports
suggest bank balance sheets may be in better shape than
expected.
                                
 Surprisingly, investors didn't flock to their favorite safe
haven of Treasuries. U.S. debt prices retreated sharply,
pushing yields to five-month highs, after a weak auction of
30-year Treasury bonds reinforced a rout triggered early in the
session by a decline in weekly jobless claims. Furthermore, the
U.S. dollar fell against the euro and other currencies.
                                
 Bank stocks also had a rough day.
                                
 The KBW Bank Index <.BKX> of 24 large lenders, including 14
that are subject to the stress tests, dropped nearly 3.50
percent ahead of the results. The index had jumped 25.8 percent
in the first three days of the week and had more than doubled
since bottoming on March 6.
                                
 "From my perch, investors should sober up and reduce their
holdings in financials now," said hedge-fund manager Doug Kass,
founder and president of Seabreeze Partners Management.
"Financial stocks are now priced to perfection."
                                
 The Dow Jones industrial average <.DJI> closed down 102.43
points, or 1.20 percent, at 8,409.85. The Standard & Poor's 500
Index <.SPX> ended down 12.14 points, or 1.32 percent, at
907.39. The Nasdaq Composite Index <.IXIC> finished down 42.86
points, or 2.44 percent, at 1,716.24.
                                
 Among other indexes, the Russell 2000 index <.RUT> was down
2.41 percent at 492.94. The New York Stock Exchange Composite
Index <.NYA> was down 1.54 percent, at 5,800.09. The Dow Jones
Wilshire 5000 Composite Index <.DWC> was down 1.53 percent at
9,269.29.
                                
 Major European indexes were lower, after six consecutive
days of gains. Drugmakers and miners weighed on the market, and
financials fell ahead of the stress test results. The
FTSEurofirst 300 index <.FTEU3> lost 0.84 percent, with the
banking sector one of the biggest risers, while Germany's DAX
<.GDAXI> fell 1.6 percent.
                                
 But shares in Asia continued to rally. Japan's Nikkei stock
average rose 4.6 percent to a 6-month closing high on Thursday
as bank shares rallied. Mitsubishi UFJ Financial Group <8306.T>
gained more than 15 percent and Mizuho Financial Group <8411.T>
rose 12.1 percent. In Hong Kong, the Hang Seng index gained 2.3
percent <.HSI>.
                                
 The euro strengthened as investors reacted positively to
news that the European Central Bank would purchase up to 60
billion euros in debt securities outright in order to help
revive the struggling euro zone economy. The news came as the
European Central Bank elected to reduce the bank's main
interest rate to 1.0 percent from 1.25 percent. The moves mark
a more aggressive move by the ECB to boost money supply in the
euro zone, which ECB President Jean-Claude Trichet said is
growing at a slower pace than desirable.
                                
The euro <EUR=> was up 0.46 percent at $1.3378 from a
previous session close of $1.3317. Against the Japanese yen,
the dollar <JPY=> was up 0.57 percent at 98.99 from a previous
session close of 98.430.
                                
 Meanwhile, the U.S. Dollar Index <.DXY> was down 0.17
percent at 83.862 from a previous session close of 84.001.
                                
 Many parts of the yield curve were under pressure. The
benchmark 10-year U.S. Treasury note <US10YT=RR> was up 1-21/32
in price, with the yield at 3.36 percent, but the 2-year U.S.
Treasury note <US2YT=RR> was down 2/32, with the yield at 1.01
percent.
                                
 The biggest loser, however, was the 30-year U.S. Treasury
bond <US30YT=RR>, which was down 90/32, with the yield at 4.27
percent.
                                
 In energy and commodities prices, U.S. light sweet crude
oil <CLc1> fell 0.04 percent to $56.32 per barrel and spot gold
<XAU=> rose 0.04 percent to $910.30 an ounce. The
Reuters/Jefferies CRB Index <.CRB> was up 0.86 percent at
239.53.
 (Editing by James Dalgleish)