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MADRID (Reuters) - Spain's economy sank deeper into recession in the second quarter, its central bank said on Monday, as investors spooked by a funding crisis in its regions pushed the country ever closer to a full bailout.
Economic output shrank by 0.4 percent in the three months from April to June having slumped by 0.3 percent in the first quarter, the Bank of Spain said in its monthly report.
Economy Minister Luis de Guindos ruled out a full-scale financial rescue on top of the 100 billion euros already earmarked for the country's banks, but Spain's sovereign bond yields stayed mired in the danger zone.
In contrast to de Guindos, who told lawmakers there was little else Spain could do to ease the tensions after launching a 65-billion-euro austerity package last week, the central bank's deputy governor said more belt-tightening was needed.
"(Current market tensions) reflect problems in Spain as well as the euro zone," Fernando Restoy said after a conference in Madrid.
"We need to continue further along the same line. We need more cuts, more reforms which will restore market confidence and mechanisms which will strengthen the monetary union."
Earlier, media reports suggested half a dozen regional authorities were ready to follow Valencia in seeking financial support from Madrid.
Prohibitively high refinancing costs have virtually shut all of the 17 regional governments out of international debt markets, forcing the worst hit to seek loans from the central government to meet bond redemptions.
Spain's sovereign debt yields rose above 7.5 percent on 10-year paper on Monday, well above the 7 percent level that triggered the spiral in borrowing costs that led to bailouts for other euro zone states.
In a sign of a growing awareness among the euro zone's heavy hitters of the need to protect Spain, Economy Minister De Guindos will travel to Berlin on Tuesday to meet with his German counterpart Wolfgang Schaeuble.
"We believe that the reforms already begun by Spain will help calm the markets," Schaeuble's spokeswoman Marianne Kothe said in Berlin, adding that the regions' funding problems had "nothing to do with" the European rescue deal for the country's banks.
Germany knew of no plans for a broader Spanish bailout request, she said.
Asked about that option on the sidelines of a parliamentary hearing on the bank aid, De Guindos said: "Absolutely not."
The mounting unease was reflected in financial markets.
Spanish two-year bond yields were up almost 90 basis points at 6.64 percent and the cost of insuring Spanish debt against default rose to a record high.
With the blue-chip stock market index Ibex hitting its lowest level since 2003, Spain reintroduced a temporary ban on short selling on Monday to discourage speculative trading.
But the ban, matching a restriction imposed on Monday in Italy, stoked fears that Spain's sovereign debt and banking crisis may be more widespread than expected, sending European shares to new intraday lows. They later recovered in Spain and Madrid stock market fell 1.1 percent on the day.
Spain slipped into recession for the second time since 2009 in the first quarter of this year, its economy crippled by a bank sector weighed down by soured assets from a collapsed property bubble and unemployment rates that have risen close to 25 percent.
The government said on Friday it expected the economy to continue to shrink well into next year, fuelling market and massive protests.
For the 12th day running, government employees demonstrated against the cuts programme in the main cities of the country on Monday, blocking roads and stopping traffic.
In his comments to parliament, de Guindos hinted the European Central Bank - hitherto unwilling to relaunch stalled stimulus programmes that might offer relief to Spain and other states at the sharp end of the euro zone debt crisis - should now step in.
Asked whether ECB intervention was needed, De Guindos said: "I repeat that in this situation of uncertainty and excessive volatility... the only way to act goes well beyond the capacity of governments."
There was however little sign that the Frankfurt-based institution would move any time soon and Ireland's Prime Minister Enda Kenny warned the Spanish situation was getting very serious.
"They're effectively locked out of the long term markets. Obviously it's an economy with huge figures and from that point of view it's one of a number of countries now which face very challenging positions," Kenny told national broadcaster RTE.
Meanwhile, Spain's central bank said an accelerated programme of structural reforms could offset the impact of the deep austerity programme, aimed at shrinking one of the highest public deficits in the euro zone.
It called for great sector liberalisation to improve competitiveness, the reduction of administrative red tape and the improvement of transparency in good and services markets.
"This should offset the negative short-term effect of the higher fiscal restrictions and, above all, will determine the economy's medium- and long-term growth potential and productivity," the bank said in its monthly bulletin.
Additonal reporting by Stephen Brown in Berlin and Padraic Halpin in Dublin, Writing by John Stonestreet and Paul Day; Editing by Julien Toyer, Ron Askew