Spain sank deeper into the mire on Monday as figures showed the economy shrinking even faster and its long-term borrowing costs jumped to danger zone highs.
The Bank of Spain said the economy contracted 0.4 per cent in the second quarter, worse than the 0.3 per cent of the first and after the government said Friday the recession would continue next year, instead of end with modest growth as it previously forecast.
The bad data compounds Madrid's pressing problems, chief among them how to cut an unprecedented unemployment rate of more than 24 per cent while at the same time stabilizing a stricken banking system and the public finances.
In morning trade, the yield – the rate of return investors earn – on the benchmark Spanish 10-year government bond jumped to 7.466 per cent from 7.225 per cent on Friday, well above the 7.0 per cent danger level for long-term funding.
Borrowing costs for other struggling euro zone states were also under pressure as the debt crisis returned with a vengeance despite an EU bank rescue deal worth up to €100-billion ($122-billion U.S.) for Spain being finalized Friday.
The Italian 10-year bond yield jumped to 6.377 per cent from 6.149 per cent.
Any yield over 6.0 per cent is widely seen as unsustainable for long-term funds, with 7.0 per cent the level at which Greece, Ireland and Portugal had to ask for outside help from the EU and International Monetary Fund.
European stock markets also fell sharply Monday, with Madrid down 4.32 per cent at around 0900 GMT after it slumped nearly 6.0 per cent on Friday, as once again the banks posted large losses. In Italy, stocks slumped 3.06 per cent.
London fell 1.54 per cent, Paris was down 1.67 per cent and Frankfurt shed 1.37 per cent following heavy losses in Asian trade.
The Spanish government recently announced massive spending cuts and other measures to stabilize its public finances but the austerity program seems only to have driven speculation that Madrid may need a full EU-IMF bailout.
Since the Spanish economy is much larger than those of Greece, Ireland and Portugal combined, there are growing raised concerns that EU rescue mechanisms might not be enough to cope, especially if Italy has problems too.
"Europe is definitely a drag on risk assets again this week as investors are worried that Spain's debt burden could be bigger than expected and that a full bailout may be required," said Peter Esho at CityIndex in Australia.
"The fresh tensions over the euro zone will hit risk assets," Crédit Agricole CIB analysts said in a note.
The euro was similarly losing ground, trading at around two-year lows at $1.2102, down from $1.2152 in New York late Friday.
On Friday, the EU approved the bank bailout deal for Madrid but any positives were more than outweighed by news that the Valencia region was to ask the central government for financial aid.
Reports – strongly rejected – that Murcia might also need help jangled nerves further.
Spain last year missed its public deficit target of 6.0 per cent of economic output by a wide margin, coming in instead at 8.9 per cent, with the 17 regional governments, which fund education and health, largely blamed for the blowout.
Greece meanwhile moved back onto centre stage as EU and IMF officials readied for a review this week which will determine whether its struggling economy gets another cash injection to keep it afloat beyond the summer.
At stake are €11.5-billion in spending cuts in 2013-2014 which Greece was originally supposed to identify in June under agreements signed earlier this year and a privatization drive that is months behind schedule.
The report will determine whether Greece will receive fresh loans of €31.5-billion ($38-billion) by September under its debt rescue program.
Without this money, the Greek government will be unable to redeem maturing debt and keep up with salary and pension payments at home.