Spanish economy shrinks by 0.3% sparking banking fears
Confidence in the European banking system has taken another hammering as worries centre on the crumbling health of the Spanish economy.
News the region's economy shrank by 0.3% in the three months to the end of June, following a 0.4% contraction in the previous quarter, has confirmed fears Spain's austerity measures are denting its growth and that its government might need a full-blown bailout.
The FTSE 100 Index fell more than 2% on speculation that a raft of Spanish regions were poised to ask for government bailout funds, increasing the likelihood that the country itself will turn to the EU for help.
Spain has already been granted a €100bn (£80bn) bailout for its banks, but has so far avoided following in the footsteps of Greece, Ireland and Portugal and taking EU assistance for the country.
But the Valencia region on Friday said it would be the first to seek financial help from an €18bn (£14bn) fund set up to help the country's regions.
And Murcia's government on Sunday said it was "studying whether to apply" for assistance.
The yield on 10-year Spanish bonds rose to a euro-era high of 7.5% in a sign that investor confidence in the country's ability to control its finances is increasingly waning.
And the pound continued to soar against the battered euro, hitting 1.28, as the eurozone debt problems drove investors to the relative safe haven of the UK currency.
Vincent Forest, economist at the Economist Intelligence Unit, said: "It is now clear that Spain has entered a self-defeating cycle of austerity and economic contraction."
But borrowing costs also rose in Italy, which has been caught up in fears that it may soon be pushed into asking for assistance as well.
Italy's economy is stagnating and markets are worried that it may soon not be able to maintain its debt burden of €1.9trn (£1.5trn).
Greece also returned to focus as officials from the EU, European Central Bank (ECB) and International Monetary Fund (IMF) prepared to meet with the country's government to discuss progress with its budget pledges.
If Greece is unable to deliver the spending cuts and tax reforms necessary then the so-called troika are unlikely to be forthcoming with further aid and a Greek exit from the single currency bloc will be back on the cards.
David Jones, chief market strategist at IG Index, said: "Those of a superstitious nature may be drawing parallels with this time last year, when heightened concerns about Greece saw the FTSE lose 1000 points in the first two weeks of August.
"There is nothing to suggest that today's slide heralds a drop of this magnitude, but traditional low summer volumes could well accentuate market nerves in the days ahead."