UPDATE 2-Spain may extend state of emergency after strike

* Spain will extend state of emergency if needed - PM

* Ruling allows govt to draft in army, makes walkout illegal

* IBEX index falls 1 pct, risk premium on bonds rises

(Releads, adds market reaction, byline)

By Judy MacInnes

MADRID, Dec 6 (Reuters) - Spain will extend a state of emergency if needed to prevent further travel disruption, its prime minister said on Monday, after a wildcat strike by air traffic controllers grounded flights last week.

Controllers only returned to work after the Socialist government sent in the army to take over control towers and threatened controllers with jail.

“Depending on how the circumstances evolve, the government will take the appropriate decision on extending the measure,” said Prime Minister Jose Luis Rodriguez Zapatero.

The walkout on Friday came just hours after the government passed new economic measures regulating controllers’ working hours and pledging to sell part of state-owned airport authority AENA for up to 9 billion euros ($12 billion).

The government, which has hit a low in opinion polls, has responded to market pressure with tax rises, asset sale plans and promises of welfare and pension reform as it fights to cut its budget deficit and calm concerns it may need a bailout.

“If a situation of this type occurs again, and I’m certain it won’t, we have more capacity, or new capacity to react,” Zapatero told a press conference ahead of a celebration of Spain’s Constitution Day.

Spain has been in the full glare of investor attention since Ireland was forced to ask for 85 billion euros in aid, sparking concerns the debt crisis could spread across the euro zone’s economies. [ID:nLDE6B11H5]

The initial response from nervous markets to the unofficial industrial action and the 15-day state of emergency was muted. The benchmark IBEX .IBEX stock index slipped 1 percent and the risk premium on Spanish bonds ES10YT=TWEB rose.[ID:nLDE6B50LO]

The government promised there would be no repetition of the travel chaos which ruined a busy holiday weekend for hundreds of thousands of Spaniards, causing serious economic damage.

Earlier El Mundo newspaper said Spain may extend the state of emergency for two months to train military personnel to take over the jobs of those air traffic controllers who are sacked or face legal action, citing an unnamed government source.

The declaration of a state of emergency is the first time the measure has been used since the death of dictator Francisco Franco in 1975, which began Spain’s modern democratic era.

Newspaper reports put the initial losses for Spain’s tourism sector, which accounts for about 11 percent of gross domestic product, at about 400 million euros.

But some analysts said this figure seemed high when compared with the about 250 million euro cost of the travel problems caused by the Icelandic volcanic ash cloud in April.

Spain’s airport authority Aena has initiated 440 disciplinary proceedings against the air traffic controllers, Blanco said over the weekend.

Air travel began to return to normal on Monday, a public holiday, with more than 500,000 people having travelled from Spain’s airports since Saturday afternoon, according to reports on national radio. (Additional reporting by Paul Day; Writing by Alexander Smith; Editing by Maria Golovnina)