European Central Bank is not yet ready to intervene in Italy

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Month-end dollar selling by Japanese exporters is also seen as behind the dollar's fall, market players said. Then, it could just hint at an extension while taking another six weeks to see how the political situation in Italy and the trade conflict with the USA play out, and take in more economic data.

Apart from developments in Italy, investors are also looking to the upcoming euro zone consumer price data at 0900 GMT, which is expected to show inflation has accelerated to 1.6 percent in May. The Spanish IBEX 35 sank 2.2 percent.

Short-dated Italian bond yields - a sensitive gauge of political risk - soared as much as 150 basis points to their highest since late 2013 in their biggest move in 26 years.

'Italy has named Carlo Cottarelli as the caretaker prime minister, but traders are nervous about the next general election, which could be as early as August.

The STOXX Europe 600 Index fell 1.8%, which is its biggest fall in more than 12 weeks.

This would be especially sensitive in heavily-indebted Italy, which is hit by a political crisis and closely benefits from the European Central Bank bond-buying programme. China's official factory gauge rose more than estimated in May while services also improved, signaling that the expansion remains robust even as debt curbs and trade tensions with the US cloud the outlook.

On Tuesday, the prospect of a snap election - likely to lead to a eurosceptic government that could put Italy's euro zone membership in question - hit Italian bonds, shares and pushed the euro to multi-month lows.

Japan's Nikkei 225 slumped 0.9 percent to 22,280.91 while South Korea's Kospi was down 0.7 percent to 2,460.75. The Hang Seng in Hong Kong slipped 1.5 per cent to 30,034.07 and the Shanghai Composite index fell 1.6 per cent to 3,072.76.

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The Australian and New Zealand dollars were steady at US$0.7545 and US$0.6939, respectively.

With a political crisis brewing in Rome, and the threat to the euro project it represents, this triggered a rush to traditional safe havens like United States debt.

"President (Donald) Trump has not accomplished very much in terms of trade issues and is likely to remain vocal with the US mid-term elections coming up".

ENERGY: Benchmark U.S. crude fell 1.1 percent to $67.13 a barrel in NY.

Oil struggled under pressure from expectations that Saudi Arabia and Russian Federation would pump more oil to counter potential supply shortfalls from Venezuela and Iran, even as USA output has surged in recent years.

USA crude futures dropped to six-week low of $65.80 per barrel, shedding 3.1 percent and is on course to post its fifth day of decline.

Energy had the highest rate of inflation at six per cent, reflecting increased oil and gas prices, followed by food, alcohol and tobacco on 2.6 per cent, services on 1.6 per cent and industrial goods on 0.2 per cent.