Growth, Spanish debt woes hit euro and shares

LONDON (Reuters) - The worsening outlook for the world economy and uncertainty about Spain's bank bailout pushed the euro to a 3-1/2 year low against sterling and drove safe-haven German bond prices higher on Monday.

World equities were also lower but investors were trading cautiously ahead of the start of U.S. Federal Reserve Chairman Ben Bernanke's two-day congressional testimony on Tuesday.

They are waiting to see if he hints at new monetary policy steps to support the U.S. economy after central banks from Europe, China and Brazil earlier this month cut interest rates to bolster fragile growth.

An index of U.S. sentiment on Friday pointed to a slowdown in consumer spending and June jobs data disappointed earlier in the month, adding to evidence that the U.S. recovery is slowing.

"2012 is turning out to be a slightly worse year for the U.S., for China and for Europe," said Sarah Hewin, senior economist at Standard Chartered in London.

"We're seeing the three large regions of the (global) economy all experiencing below potential growth and, in the case of Europe, we think we'll see a recession for the year as a whole," she said.

SPANISH WORRIES

In foreign exchange markets, the euro's weakness against the dollar and sterling was exacerbated by a report suggesting a change in the European Central Bank's stance on how some bondholders could be treated under Spain's bank bailout.

The Wall Street Journal said ECB President Mario Draghi advocated imposing losses on holders of senior bonds issued by the worst hit Spanish savings banks.

The ECB declined to comment on the report, which also said finance ministers rejected the advice due to concerns financial markets would react badly to such a decision.

"The euro is likely to remain on the defensive ... If this report gains credibility that would be another reason to play the euro from the short side," said Jeremy Stretch, currency strategist at CIBC.

The euro was down 0.2 percent at $1.2223, just above last week's two-year low of $1.2162 and had touched a low of 78.55 pence against sterling, its weakest level since late 2008.

The final terms of the 100 billion Spanish bank bailout package are expected to be agreed by euro zone finance ministers this Friday.

German debt, which has been a shelter from the rise in yields on Spanish and Italian bonds, extended a week of gains on Monday with confidence the bank bailout would resolve the problems facing Spain beginning to ebb.

Germany's 10-year bond was yielding around 1.24 percent, down one basis point, while Spanish 10-year bond yields were 8 basis points higher at 6.74 percent. Equivalent Italian bonds gained 7 basis points to yield just over 6.0 percent.

European shares edged lower with investors reluctant to push the market higher after six weeks of gains because the early stages of the second quarter earnings season has shown signs the euro zone debt crisis is weighing on profits.

The FTSE Eurofirst 300 index of top European shares was down 0.15 percent at 1041.47 points.

The MSCI world equity index was also fractionally lower at 309.18 points despite Asian shares having posted a stronger session after gross domestic product data on Friday suggested China may not face an economic hard landing.

China's Premier Wen Jiabao said the government would step up efforts to boost the economy and this helped lift Brent crude prices 6 cents to $102.46 a barrel and underpinned gold which was little changed at $1,589.75 an ounce.

(Additional reporting by Jessica Mortimer; Editing by Anna Willard)