WRAPUP 1-Spain, Italy slide further into euro zone crisis
* Spanish 10 year bond yields jump past 6 percent
* Madrid may impose budget curbs on regions in return for credit
* Italy to cut growth forecasts, vows to stick to budget plan
By James Mackenzie and Sarah Morris
ROME/MADRID April 16 (Reuters) - Spain and Italy faced growing market pressure on Monday, stoking fears of a new phase in the euro zone debt crisis as Madrid's budget problems threatened to drag in other southern European economies.
Yields on Spanish 10-year bonds have climbed over 6.1 percent, nearing levels that caused general market panic when Italy was in the same position late last year.
Italian 10-year yields stood at almost 5.6 percent, while the yield on safe-haven German Bunds was just over 1.6 percent, the lowest since the height of the financial turmoil in 2008.
"We are back in full crisis mode," said Rabobank strategist Lyn Graham-Taylor.
Spain, the euro zone's fourth-largest economy, is at the centre of the crisis as concerns grow about some of its banks and the impact of the austerity policies of Prime Minister Mariano Rajoy's conservative government on a struggling economy.
As the psychological boost from huge injections of cheap cash by the European Central Bank earlier this year has faded and the sustainability of Spanish public finances is questioned, the euro zone has been thrust back on to the agenda of International Monetary Fund meetings this week.
Madrid said it would have to impose further cuts on regional governments, some of which have failed to pay contractors' bills for months, and acknowledged that the economy had tipped back into its second recession since 2009.
"It is looking more and more likely that Spain is going to have some form of a bailout. Assuming there is not an (ECB) intervention you would not see a cap on Spanish yields, they would just keep increasing," Graham-Taylor said.
The ECB has intervened only sporadically since flooding the market with funds in February and appears reluctant to resume bond purchases. Governing Council Member Klaas Knot said on Friday he hoped the bank never has to use the programme again.
In an interview with the daily El Mundo, Economy Minister Luis de Guindos said first quarter growth figures, due on April 30, would show a similar pattern to the last quarter of 2011, when the economy contracted 0.3 percent, but would not be worse.
"If you had asked me two months ago, I would have expected the first quarter of 2012 to be much worse than the last quarter of 2011. But that is not going to be the case," he said.
In Rome, new Italian growth forecasts, which had been expected on Monday were delayed until Wednesday, but a similarly bleak picture is expected when they are announced.
On Monday, Economy Ministry Undersecretary Gianfranco Polillo said Rome was set to lower the forecast for 2012 output, which predicts a 0.4 percent contraction for the euro zone's third biggest economy.
But he said the new forecast would probably come in better than the European Commission's forecast of a 1.3 percent contraction.
The market tensions have caused growing political friction between the two countries and Italian Prime Minister Mario Monti was forced to phone Rajoy last week to try to soothe his anger at a series of comments from Italy blaming the turmoil on Madrid.
Monti received some encouragement on Monday from ratings agency Fitch, which called the government's fiscal plans "credible" even if prospects of it fulfilling a pledge of a balanced budget by 2013 were receding.
The Italian cabinet had been due to meet later on Monday to cut its growth forecasts for 2012 but approval of the latest government macroeconomic projections was put off until Wednesday as budget experts worked to meet requests for additional information from the European Union.
Officials said the lower forecast should not affect the pledge of a balanced budget in 2013 made by former Premier Silvio Berlusconi and taken on by Monti's technocrat government.
"I can say today that we expect to achieve the targets as announced. There may be variations but they won't change the overall framework," European Affairs Minister Enzo Moavero Milanesi said.
APPROVAL RATING FALLS
The fresh market crisis, following months of relative calm at the start of the year, has added to the problems facing Monti after a honeymoon phase in which he was hailed for rescuing Italy from the scandal-filled Berlusconi years.
A poll on Monday from the SWP polling institute showed Monti's approval ratings at 47 percent, still way above any of the political parties but well down on the 59 percent he enjoyed just over a month ago.
Difficult reforms of labour market rules to make it easier for companies to dismiss staff have roused opposition from trade unions and the left while failing to gain full support from business leaders and the centre-right.
A renewed outbreak of political squabbling, ahead of local elections on May 6, has underlined the challenge facing Monti and the broader leadership of the European Union as they seek to convince markets that a solution to the crisis is possible.
"The mistake that a lot of politicians and ordinary citizens are making unfortunately is to expect all our problems to be solved and the recession to be over tomorrow," former Foreign Minister Franco Frattini, now a senior figure in the centre-right PDL party, told Reuters. "It's just not possible."
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