Global shares, euro capped on Spain contagion fears

TOKYO (Reuters) - Asian shares were capped on Tuesday after the previous day's deep losses as a surge in Spain's borrowing costs, to levels seen as unsustainable, triggered alarms indebted regions could push the euro zone's fourth-largest economy to seek a bailout.

The euro was not far from a two-year low against the dollar and a near 12-year low against the yen, as the single currency was undermined by Moody's Investors Service changing its ratings outlook to negative for Aaa-rated Germany, the Netherlands and Luxembourg amid Europe's ongoing debt crisis.

With market sentiment so fragile, data showing China's manufacturing output in July grew at its fastest pace in nine months offered some relief, helping Asian shares trim some earlier losses and also slightly boost the commodity-linked Australian dollar to $1.0288 from around $1.0265.

The HSBC Flash China manufacturing purchasing managers index (PMI) rose to 49.5 in July to its highest level since February, driven up by a jump in the output sub-index to its best showing since October 2011.

It is the first significant Chinese data in the third quarter and signals that pro-growth government policies are supporting improvement in the world's second-largest economy.

"The data gave a slight boost to markets, but whether such effects are sustainable are doubtful as Europe struggles with its problems," said Hiroyuki Kikukawa, general manager at trading company Nihon Unicom.

"Government policies will underpin the Chinese economy over the longer term, but in the short-term, instability in the European situation will keep a drag, especially as Europe is a big export market for China," he said.

MSCI's broadest index of Asia-Pacific shares outside Japan eased 0.1 percent, after tumbling 2.4 percent on Monday for its biggest one-day drop in about two months, while Japan's Nikkei stock average lost 0.4 percent and slipped to a six-week low.

Hong Kong's stock market will resume trading at 0500 GMT after the morning session was cancelled due to Typhoon Vicente.

The euro was at $1.2123, off a 25-month low of $1.2067 hit on Monday, and stood at 94.87 yen, barely above its lowest since November 2000 of around 94.23 yen marked on Monday.

Fears about Spain possibly needing a fully-fledged bailout intensified investor flight to safety and pushed the 10-year U.S. Treasury yield down to a record low 1.3977 percent, while five- and 10-year German government bond yields also set new lows on Monday.

In contrast, Spanish 10-year borrowing costs surged to a euro-era high above 7.5 percent on Monday.

Andrew Wilkinson, chief economic strategist at Miller Tabak & Co in New York, said the flattening of the Spanish yield curve reflected how investors have grown increasingly concerned about perceived risks facing Spain.

"Rising yields are in turn adding to a sense of crisis: If the regions ask for cash, how will the government fund itself? The brave Spanish matador appears to be pinned to the perimeter fence by the angry bull," Wilkinson said.

Spain faces a crucial litmus test later on Tuesday with its debt sale of 3 billion euros in 3- and 6-month bills.

GREECE ENTERS AGAIN

Greece, which only last month averted a crisis by having pro-bailout parties win an election, is scheduled on Tuesday to meet its troika of creditors -- the European Union, European Central Bank and the International Monetary Fund -- to renegotiate rescue payments which are crucial to keeping indebted Athens afloat and within the euro zone.

The uncertainty over whether Greece could convince creditors to secure the funds compounded fears Madrid's funding crisis could accelerate after Spain's central bank said on Monday the economy sank deeper into recession in the second quarter.

Euro zone's manufacturing data is also due later on Tuesday.

Various gauges for stress on Monday reflected mounting market nervousness about financial contagion from the fiscal woes in Spain and Greece, pushing risk premiums on dollar funding wider and lifting the CBOE Volatility index , which measures expected volatility in the Standard & Poor's 500 index over the next 30 days, up 14.4 percent to 18.62.

The general risk aversion weighed on Asian credit markets, sending the spread on the iTraxx Asia ex-Japan investment-grade index wider by 4 basis points.

Oil steadied after Brent fell more than 3 percent and U.S. crude fell 4 percent on Monday. Brent crude futures was up 0.2 percent at $103.48 a barrel while U.S. crude stood flat around $88.16 a barrel on Tuesday.

(Editing by Michael Perry)