European shares fell on Monday as political ructions in Italy added to fears of contagion from the euro zone debt crisis, which hit cyclical stocks and banks and overshadowed a tentative deal to help push through a bailout package for Greece.

The early decline follows a 3.8 percent fall last week for the FTSEurofirst 300 , ending a five-week rally, and comes ahead of a euro zone finance minister meeting to flesh out plans to boost the region's bailout fund.

An Italian parliament vote on Tuesday to debate austerity cuts has become a key test of Prime Minister Silvio Berlusconi's government.  

The uncertainty in Rome eclipsed a political cross-party deal in Greece to approve the terms of its international bailout, which, although it was still short on detail, nonetheless boosted Greek stocks.

 'The focus is Italy; Italy's clearly the big one. Everyone expected what has come out of Greece,' Christopher Potts, strategist at Cheuvreux, said, adding: 'The whole problem is the opposition and its disarray. Who takes over and how will it be organised? No-one has the answer but it's of huge importance.

'If you get a succession organised, there's going to be a huge rally in Italian financial assets, both bonds and equities, but it's not an easy question.'

Italy's blue-chip FTSE MIB was down 1.6 percent in early trade, against 1.7 percent for the broader FTSEurofirst 300, while its benchmark government debt yields hit 6.67 percent, their highest since 1997 and edging closer to the 7 percent level seen as unsustainable.

Volatility as measured by the Euro STOXX Volatility index  , a key gauge of equity investor 'fear', was meanwhile up 7 percent at 44.35.

Banks led sectoral fallers and peripheral euro zone lenders were among the worst hit, with Spanish, Portuguese and Italian banks all contributing to a 2.7 percent weaker STOXX Europe 600 Euro Zone Banks index.

Adding to the general gloom for Italian lenders, Barclays Capital cut estimates for the Italian banks it covers, downgraded Banca Monte dei Paschi di Siena , down 4.4 percent, and said 'with expectations of capital raising imminent, investors are understandably staying on the sidelines'.

'Sovereign risks overshadow operating fundamentals for Italian banks, but are also adding direct P&L pressure via higher funding costs,' Barclays said in a note.

Amongst the bigger lenders, French banks BNP Paribas  , Societe Generale and Natixis , all of whom have large exposures to Italian sovereign debt, as well as deep retail and corporate links, were also heavy fallers.

The gradual debt crisis creep to core euro zone countries has compounded the region's recovery and led many analysts to bet on a return to recession in the coming weeks and months.

Adding further to the gloomy outlook, France is set to announce an extra 8 billion euros or more in cuts and tax increases later on Monday in an effort to keep its credit rating.

The CAC-40 was down 1.9 percent and underperforming British and German peers , down 1.6 percent and 1.8 percent, respectively, by 0901 GMT.

French retail heavyweight Carrefour was among the biggest regional fallers in early trade, down 4.6 percent after Citigroup cut its rating on the stock to 'sell' from 'neutral', citing its growing debt burden.

'We argue the market underestimates the extent to which Carrefour's leverage will drive corporate strategy, for the worse,' Citigroup analysts said in a note.

'On our numbers, Carrefour's operating cash flow barely covers capex --itself already significantly reduced --, leaving the dividend to be paid out of debt. With net debt rising and profits declining, Carrefour's balance sheet is deteriorating rapidly,' he added.-Reuters