World stocks fell on Tuesday with Asian shares leading the way as tension about North Korean nuclear tests added to questions over the global economic outlook.

Wall Street also looked set to open lower.

Pyongyang was reported to have fired two short-range missiles off its east coast, a day after testing its second nuclear device earned international condemnation.

The dollar strengthened, but remained near a five-month low hit last week against a basket of currencies. Investors sold higher-yielding currencies that had benefited from hopes the worst of the global economic crisis was over.

European shares were down sharply. The FTSEurofirst 300 lost 1.2 percent.

Earlier, Asian shares outside Japan fell 0.5 percent and South Korea's stock market was off 2 percent.

Japan's Nikkei average closed down 0.4 percent.

Analysts said the tension with North Korea was not likely to undermine stocks for long but that macroeconomic worries were stalling a rally that began in March.

I would expect the North Korea political event to weigh on the market for one or two days, not more -- markets are waiting for new macro data, new announcements, and volumes have diminished a lot in the past three weeks, said Thierry Lacraz, strategist at Swiss bank Pictet.

U.S. consumer confidence data was due later in the day.

Investors have become increasingly anxious for firm evidence of real economic revival as opposed to a simple slowing down of economic decline.

Housing data from the United States over the next few days -- existing and new home sales and building permits for April -- will come under intense scrutiny.

DOLLAR, BOND STRENGTHEN

The dollar rose broadly, particularly after a media report questioning the health of the German banking system prompted traders to trim back bets against the currency that had driven it to a five-month low last week.

Britain's Daily Telegraph reported that Germany's financial regulator BaFin had warned that toxic debt of the country's banks would prove devastating unless they took advantage of government bad-bank plans.

The report was not new, however, as the regulator warned last week that German banks have bad assets of around 200 billion euros ($280 billion).

The dollar was up 0.8 percent against a basket of currencies

and the euro lost 0.9 percent to $1.3880.

It's premature to expect that the situation in the euro zone is anything like stable enough to justify the increase in euro/dollar, said Michael Klawitter, senior currency strategist at Dresdner Kleinwort in Frankfurt.

Demand for euro zone government bonds rose. The two-year Schatz yield was down 2 basis point at 1.398 percent and the 10-year yield was down 2 basis points at 3.582 3.589 percent.

(Additional reporting by Sitaraman Shankar and Jamie McGeever; Editing by Victoria Main)

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