TORONTO - The Toronto stock market closed sharply lower Tuesday amid a debt rating downgrade for a major European bank and weaker than expected U.S. home sales numbers.

The S&P/TSX composite index dropped 138.14 points to 11,797.94 while the TSX Venture Exchange declined 15.09 points to 1,457.94.

Bond rating agency Fitch downgraded its debt rating on BNP Paribas SA -- the largest bank in the eurozone by deposits -- by one notch Monday, reviving worries that Europe's government debt problems will slow growth and undermine the financial system. Fitch slashed BNP's long-term rating to AA-minus from AA on deteriorating asset quality.

Traders are concerned that high levels of government debt across Europe, particularly in Greece, Spain and Portugal, would disrupt a global economic recovery and lead to a fresh round of losses for banks holding the debt of cash-strapped governments.

"They have obviously been taking the pencil to the ratings on some of the governments and everyone has recognized that the big exposure to sovereign debt actually resides in the European banking system," said Norman Raschkowan, chief investment officer at Mackenzie Financial Corp.

Investors were also disappointed with a report showing that U.S. home resales dipped 2.2 per cent in May, suggesting that a boost from government home-buying incentives is winding down earlier than expected. Economists had expected sales to rise last month by 6.1 per cent.

"The housing one is interesting, because there was a lot of expectation that as the stimulus for home purchases came off, that the housing market would taper off, " added Raschkowan.

Meanwhile, the Canadian dollar gave up early gains as the latest European worries pushed the euro lower and sent nervous investors to the safe haven of the U.S. dollar. The loonie closed down 0.45 of a cent to 97.17 cents US even as data showed that inflation is unlikely to worry the Bank of Canada as it considers whether to hike rates again in July.

Statistics Canada reported that falling gasoline prices helped push Canada's annual inflation rate down sharply to 1.4 per cent last month.

Prime Minister Stephen Harper hopes that China's move to let the yuan currency appreciate against the U.S. dollar will benefit the Canadian economy by easing pressure on the loonie.

"Particularly with the limitations on the Chinese currency, Canada's currency has really carried its proportion of burden of deprecation of the American and other Western currencies," Harper said in an interview with Bloomberg TV.

The Canadian dollar has advanced 11 per cent against the U.S. dollar over the past 12 months.

Oil prices fell amid waning enthusiasm over China's decision to let its currency appreciate and as investors considered whether the global economy is strong enough to justify a four-week rally.

The July crude contract on the New York Mercantile Exchange dropped 61 cents to US$77.21 a barrel. The TSX energy sector was down 2.3 per cent with Canadian Natural Resources (TSX:CNQ) down $1.09 to C$36.87 while Suncor Energy (TSX:SU) was off 81 cents to $33.73.

The base metals sector was off 3.23 per cent even as the July copper contract on the Nymex edged up five cents at US$2.99 a pound. Teck Resources (TSX:TCK.B) declined $1.10 to C$35.57 and Quadra FNX Mining (TSX:QUX) lost 78 cents to $10.54.

Gold stocks also lost early momentum as the August bullion contract in New York up a dime at US$1,240.80 an ounce.

The financial sector was also a weight, down almost one per cent with TD Bank (TSX:TD) down 63 cents to $73 while Royal Bank (TSX:RY) gave back 62 cents to $54.41.

Earlier in the day, the governments of Britain, France and Germany announced they will levy a fee on banks based on how much they earn to shield taxpayers from the cost of resolving financial crises. The three nations said they aimed to ensure that financial institutions are making a "fair contribution" to reflect the risks they pose to the financial system and "to encourage banks to adjust their balance sheets to reduce this risk."

New York markets also backed off with the Dow Jones industrial average down 148.89 points to 10,293.52. The Nasdaq composite index was 27.29 points lower to 2,261.8 while the S&P 500 index slid 17.89 points to 1,095.31.

U.S. oil stocks also fell after the U.S. government said it will appeal a ruling from a federal judge in New Orleans that blocked a six-month moratorium on new deepwater drilling projects put in place following the massive Gulf oil spill. The U.S. administration halted the approval of any new permits for deepwater drilling and suspended drilling at 33 exploratory wells in the Gulf. But the judge said that the moratorium seems to assume that because one rig failed, all companies and rigs doing deepwater drilling pose an imminent danger.

The U.S. Federal Reserve opened a two-day meeting after which it is expected to keep a key interest rate at historic lows. That move is intended to stimulate growth as a domestic recovery moves slowly.

In corporate news, Gaz Metro Inc. plans a strategic reorganization that will exchange all publicly held limited partnership units (TSX:GZM.UN) for shares of a new dividend-paying corporation on a one-for-one basis. The reorganization is in keeping with changes to federal income tax policies for income trusts and limited partnerships. Investors currently have a 29 per cent interest in Gaz Metro, which is Quebec's leading natural gas distributor. Its units were up eight cents to $15.85.

Rogers Communications (TSX:RCI.B) shares were off 14 cents to $37.20 as the company prepared to buy Bounce FM in Edmonton, the second purchase of a CTV radio station announced this week. Rogers announced on Monday that it would buy BOB-FM in London, Ont.