By Marc Jones
LONDON (Reuters) - Investors shunned European shares and the euro and favoured safe-haven German government bonds on Thursday as a heavy downgrade of Spain by rating firm S&P added to pressure on Madrid to apply for a bailout.
Standard & Poor's cut Spain's rating two notches to BBB- minus, one step from junk status, late on Wednesday, warning that an intensifying recession and poor response from euro zone policymakers to the crisis had left Spain highly vulnerable.
Many European markets opened in the red, with shares, the euro and Spanish and Italian bonds all subject to selling after Asian shares had tracked Wall Street lower following weak forecasts from U.S. corporate bellwethers.
"It doesn't bode well for Spain. We're continuing to see weaker economic numbers and the euro zone issues are still there," said Manoj Ladwa, head of trading at London-based TJ Markets. "The euro zone will dominate the month of October."
The Euro STOXX 50, which has now lost 3 percent since the start of the week, opened 0.5 percent lower with Germany's DAX, France's CAC, London's FTSE and Madrid's IBEX down between 0.1 and 1 percent lower. The euro fell 0.15 percent to $1.2855.
With investors looking to less risky assets, German government bonds rose 60 basis points to 141.83. Spanish bonds fell, with 10-year yields up 13 basis points at 5.96 percent.
Compounding the downbeat mood, IMF managing director Christine Lagarde said political wrangling was adding to economic uncertainty and prodded the world's rich countries on to take swifter action as Europe's debt crisis drags on.
"We expect action and we expect courageous and cooperative action on the part of our members," Lagarde said.
S&P's timing for its Spanish downgrade may not help fellow euro zone struggler Italy, which is set to auction 6 billion euros of mainly three-year bonds later in the day.
Tensions in the Middle East pushed oil prices up toward $115 a barrel, leaving prices less than a dollar away from their highest in almost a month.
Gold was steady after dropping more than 1 percent over the last four sessions, although gloom over the euro zone debt crisis that is supporting the dollar is expected to dull some of its shine.
(Reporting by Marc Jones; Editing by Alastair Macdonald)