Stocks dropped on Wednesday after Germany's decision to ban naked short-selling of certain financial instruments and comments from its chancellor on the safety of the euro rattled investors.

Germany banned naked short sales of euro-denominated government bonds, credit default swaps based on those bonds and shares in the country's 10 leading financial institutions in a move that appeared to catch its partners in the European Union off guard, who said they were not consulted.

German Chancellor Angela Merkel said in a speech to parliament the euro was in danger, urging speedy action to stop market extortion, and said the EU needed a process for orderly insolvency of its members.

Everyone is a little bit scared of this Europe thing -- Germany is trying to play hardball, said Terry Morris, senior equity manager for National Penn Investors Trust Company in Reading, Pennsylvania.

European shares fell sharply <.FTEU3>, by 2 percent or more, as Germany's move sparked concerns of tighter regulation, and the euro fell to a four-year low of $1.2145 before rebounding back above the $1.23 level.

In naked short selling, a trader sells a financial instrument, betting that its price will fall, without first borrowing the instrument or ensuring that it can be borrowed, as in a conventional short sale.

The Dow Jones industrial average <.DJI> dropped 68.02 points, or 0.65 percent, to 10,442.93. The Standard & Poor's 500 Index <.SPX> lost 7.41 points, or 0.66 percent, to 1,113.39. The Nasdaq Composite Index <.IXIC> fell 21.91 points, or 0.95 percent, to 2,295.35.

Hewlett-Packard Co added 0.8 percent to $47.17 after the world's largest technology company by sales reported quarterly results that beat expectations and raised its full-year earnings outlook.

Data from the Labor Department showed U.S. consumer prices unexpectedly fell in April for the first time in a year, with the core annual rate recording its smallest gain since 1966.

Later Wednesday, the Federal Reserve's policy-making committee will release minutes from its most recent meeting.

(Editing by Padraic Cassidy)

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