Spain hit by downgrades amid Greek contagion fears

It also invoked the "reduced creditworthiness" of the Spanish state, as its borrowing costs have again spiked close to bail-out territory earlier this week, which in turn makes it difficult for the government to support banks.

Even though the Spanish government last week passed a banking reform after taking over Bankia, a major lender holding some €32 billion worth of bad loans and mortgages, and the European Central Bank helped out banks with cheap loans, "Moody's believes these positive factors are overwhelmed by mounting asset-quality challenges that weaken the earnings and threaten to erode the capital positions of many banks."

The agency also cut the ratings of four Spanish regions - Catalonia, Murcia, Andalucia and Extremadura - which now hold only a "low probability that they will be able to meet the 2012 deficit target."

The European Commission warned last week that the high debts of the 17 regions, which account for about half of overall public spending, would prevent Spain meeting its goal of cutting the budget deficit to 5.3 percent of gross domestic product this year.

Spain officially slipped into recession in the first quarter this year, final figures confirmed on Thursday, with the government having to pay around five percent interests on its three and four-year bonds, almost double compared to a month ago.

And its ten-year bonds have again traded above six percent, edging closer to bail-out territory (7%), partly also because of investors fears about the stability of the eurozone as speculation about a Greek euro-exit has picked up in recent weeks.

Fitch ratings agency on Thursday downgraded Greece deeper into so-called junk territory, warning of a "probable" exit from the common currency area if the 17 June elections produce a government that scraps the €130 billion bail-out agreed in March.

"The downgrade of Greece's sovereign ratings reflects the heightened risk that Greece may not be able to sustain its membership of Economic and Monetary Union," the agency said in a statement.

US pressure

Leaders from the EU's biggest countries are set to be put under pressure by US President Barack Obama as they attend a G8 meeting in Camp David hosted by the US.

Washington is keen for the eurozone to change the austerity and deficit-driven policies that have sunk Spain and Greece into even deeper recession.

"The US welcomes the evolving discussion and debate in Europe about the imperative for jobs and growth. The US has an extraordinarily significant stake in the outcome of the economic discussions in Europe and the steps that are taken in Europe," Obama's national security adviser Tom Donilon told reporters in Washington.

EU leaders from Germany, France, Britain and Italy on Thursday held a video-conference ahead of the G8 meeting agreeing on the general concept that austerity and growth-spurring measures can go hand-in-hand. EU council chief Herman Van Rompuy and European Commission president Jose Manuel Barroso also took part in the video chat.

The office of British Prime Minister David Cameron office said the leaders had discussed the G8 and the eurozone "including Greece, growth, and the importance of expanding trade relations between the US and EU."

In the video-conference, Cameron "emphasised the importance of Greece and the eurozone taking decisive action to ensure financial stability and prevent contagion," his office said.

Earlier that day Cameron issued a stark warning, during a speech in Manchester: "The eurozone is at a crossroads. It either has to make up or it is looking at a potential break-up."