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Italian Economy Minister Giulio Tremonti met the chairman of euro zone finance ministers, Jean-Claude Juncker, for emergency talks after yields on Italian and Spanish 10-year bonds flirted with 14-year highs before calming a little.

They made no policy announcements after two hours of talks in Luxembourg.

"We had a long discussion of the problems the euro area is facing," Juncker told reporters. Tremonti called it a "long and fruitful discussion" but said nothing on the substance of the talks.

In Brussels, the European Commission said after EU monetary affairs chief Olli Rehn spoke to Tremonti on Tuesday evening that there had been no discussion of a bailout for Italy, which would overwhelm the bloc's existing rescue funds.

The EU executive said it would issue a statement later in the day about the situation on financial markets.

"Italian and Spanish bond yields rose to their new record highs. This is a very alarming and scary thing," Finnish Prime Minister Jyrki Katainen told public broadcaster YLE. "The whole of Europe is in a very dangerous situation."

Prime Minister Silvio Berlusconi, who has been largely silent, closeted with his lawyers over several ongoing trials, was due to address parliament later. His speech was put back until after Italian markets close.

Less than two weeks after leaders of the 17-nation euro zone agreed on a second bailout for Greece, Europe's worst hit debtor, and adopted measures meant to stem contagion to larger sovereigns, the debt crisis is back with full force.

With many policymakers on holiday, there seems little prospect of immediate European policy action, although Spain said on Tuesday that the main euro zone governments had held telephone contacts on the situation in the markets.

German Economics Minister Philipp Roesler said Italy and Spain were not even discussed at Berlin's weekly cabinet meeting on Wednesday which he chaired in place of Chancellor Angela Merkel, who is on vacation and did not call in.

In Rome, an Italian minister said Berlusconi's cabinet did not discuss the crisis at its weekly meeting either.

The euro zone's rescue fund cannot use new powers granted at last month's summit to buy bonds in the secondary market or give states precautionary credit lines until they are approved by national parliaments in late September at the earliest.

The European Central Bank could reactivate its bond-buying program, which temporarily steadied markets last year but has been dormant for more than four months. Weekly data released on Monday show it has so far refrained from doing so despite market rumors to the contrary last week.

Italy and Spain could offer new austerity measures to try to placate the markets, but Rome has just adopted a 48 billion euro savings package and Madrid's lame duck government has just called an early general election for November 20.

BANK SHARES HAMMERED

Shares in banks exposed to euro zone sovereigns, particularly in Italy, have taken a hammering and are having growing difficulty in securing commercial funding.

"Bank funding remains stressed for southern Europe and remains a key source of risk for bank earnings, ability to lend and a drag on economic recovery," Huw van Steenis, analyst at Morgan Stanley in London, said in a note. "The risk of a credit crunch in southern Europe is growing."

Shares in Italian banks fell further at Wednesday's opening but rebounded after data showed the Italian services sector contracted by less than expected in July.

But the ripples continue to spread.

France's Societe Generale warned investors it may miss its 2012 profit target after taking a 395 million euro pretax charge in the second quarter on its exposure to Greek debt.

The Swiss National Bank cut its interest rate target and said it would very significantly increase its supply of liquidity to try to bring down the value of the Swiss franc, which it said has become massively overvalued.

The currency has served as a refuge, along with gold, amid market turbulence driven by anxiety over a slowing U.S. economic recovery and Europe's debt crisis.

Unlike in previous years, when trading volumes in euro zone bonds dropped off in the August holiday season, volumes in Italian BTP futures have been higher, although the bid/offer spread has widened, according to Reuters data.

Worries about Italy, the euro zone's third largest economy and second biggest debtor, have been exacerbated by political instability in Berlusconi's fractious center-right coalition.

The Italian parliament approved an austerity program last month but doubts have lingered about a weakened government's ability to enforce the cuts, and about the lack of structural reforms to boost Italy's miserable growth rate.

"For both Spain and Italy, the 7 percent level in yields is the one everyone is focused on," said West LB rate strategist Michael Leister. "Although we're still quite a decent amount away from that, any break of the 6.50 percent level is going to be a catalyst to get to those higher rates."

On Wednesday, Spanish and Italian 10-year yields stood respectively at 6.28 and 6.16 percent. The gap between them has narrowed as Italy has overtaken Spain as the main focus of market concern about debt sustainability.

(Additional reporting by Kirsten Donovan, Swaha Pattanaik and Alex Chambers in London, Gernot Heller in Berlin, Katie Reid in Zurich; writing by Paul Taylor; editing by Janet McBride/Mike Peacock)

The United States had its triple-A rating confirmed by two key ratings agencies on Tuesday after Washington struck a last-minute deal to avoid a debt default, but threats of future downgrades remain.

Moody's Investors Service and Fitch Ratings maintained U.S. ratings for now, but said more deficit-reduction measures were needed for the government to put its finances in order and retain the coveted rating. Underscoring that threat, Moody's assigned a negative outlook to the Aaa rating, which means a downgrade is possible in the next 12 to 18 months.

China's central bank governor urged Washington on Wednesday to act responsibly to deal with its debt issues, saying uncertainty in the U.S. Treasuries market would undermine the international monetary system and hamper global growth.

Benchmark U.S. Treasury yields hit a nine-month low, and the yield curve flattened further on Wednesday as more investors fled equities for bonds on heightened anxiety about a global slowdown and the deteriorating debt crisis in Europe.

Banking stocks will be in focus after French lender Societe Generale (SOGN.PA) warned it would struggle to reach its profit target next year as weak asset management revenues and a hit from its contribution to the Greek bailout took their toll on second-quarter earnings. SOGN.PA-E

Bank of America Corp (BAC.N) has told state and federal officials that it wants protection against future litigation relating to mortgage servicing and in exchange is willing to reduce the amount owed by some of its troubled borrowers, the Wall Street Journal said, citing people familiar with the talks.

Following a string of bleak economic data, investors braced for the monthly ADP jobs figures, due at 1215 GMT, a harbinger for Friday's non-farm payrolls.

On the earnings front, investors awaited results from companies including Constellation Energy Group (CEG.N), Clorox Co (CLX.N), Comcast (CMCSA.O), Devon Energy (DVN.N), Mastercard Inc (MA.N) and Time Warner Inc (TWX.N).

European stocks were down about 0.9 percent in morning trade, led lower by a sell-off in mining shares such as BHP Billiton (BLT.L), although Spanish and Italian shares regained ground, taking a breather after suffering huge losses earlier this week. .EU

Growth in the euro zone's dominant service sector eased to its weakest rate in nearly two years in July as backlogs of work fell for the first time since late last year, a key survey showed on Wednesday.

The Swiss National Bank cut its interest rate target band on Wednesday in a surprise move to stem the rapid rise of the Swiss franc, which investors have flocked to, seeking harbor from the European and U.S. debt crises.

The S&P 500 turned negative for the year on Tuesday as the wrangling over the U.S. debt ceiling faded and investors turned their attention to the stalling economy. The broad-based index fell for a seventh day and crashed through its key 200-day moving average in an ominous sign for markets. The seven days of losses mark the longest losing streak since October 2008.

The Dow Jones industrial average .DJI dropped 265.87 points, or 2.19 percent, to 11,866.62. The Standard & Poor's 500 Index .SPX dropped 32.89 points, or 2.56 percent, to 1,254.05. The Nasdaq Composite Index .IXIC dropped 75.37 points, or 2.75 percent, to 2,669.24.

(Reporting by Blaise Robinson; Editing by Will Waterman)

Completion of a last-gasp deal to avoid a U.S. default failed to bring any relief, as investors focused instead on how tighter fiscal policy could constrict U.S. growth and Europe's debt crisis was still worsening.

"I think the conditions have completely changed this week," said Koichi Ono, senior strategist at Daiwa Securities Capital Markets in Tokyo. "Until last week, people have been saying the U.S. debt ceiling was the problem. Now they talk about worries about the health of the economy."

In Europe, financial spreadbetters were calling the major share indexes to open down 1.3-1.4 percent. .EU .L

Views on the economic outlook were rapidly being revised, with JPMorgan cutting its forecast on 2012 U.S. growth to 1 percent and markets reflecting expectations of more than 80 basis points of rate cuts in Australia -- 60 basis points more than a day ago -- contributing to the Australian dollar's slide below $1.07.

U.S. consumer spending fell in June for the first time in nearly two years and incomes barely rose, signs that the economy lacked momentum as the second quarter drew to a close, data on Tuesday showed.

That followed Monday's manufacturing data from the United States, Europe and China showing growth near a standstill and last week's disappointing second-quarter U.S. GDP estimate. A series of U.S. employment data releases from Wednesday through Friday will be closely watched.

"The market is standing on the edge of the cliff. U.S. manufacturing activity, growth rate, employment data are all close to a critical point," said Kim Se-jung, a strategist at Shinyoung Securities in Seoul.

Japan's Nikkei share average .N225 fell 2.2 percent and MSCI's broadest index of Asia Pacific shares outside Japan .MIAPJ0000PUS fell 2.4 percent, slipping below its 200-day moving average, an indicator of the medium-term trend. .T

Australian shares .AXJO fell 2.1 percent and South Korean stocks .KS11 dropped more than 2.5 percent. .AX .KS

EARNINGS DOWNGRADES

Asia equity markets that are particularly exposed to swings in global business cycles and commodities prices have been seeing earnings downgrades.

Taiwan, where about half of the equity market cap is in the technology sector, has been the biggest target of downward EPS revisions in Asia Pacific, according to Thomson Reuters StarMine SmartEstimates, which gives a greater weighting to the more accurate forecasters.

Analysts have in the past 30 days cut their EPS estimates for Taiwanese companies this year by an average 5.5 percent, more than twice the next market with the biggest downgrades, Australia at 2.4 percent, the SmartEstimates show.

On the flip side, frontier markets such as Vietnam and Pakistan as well as markets with companies that depend mostly on domestic demand, such as Indonesia, have seen upgrades of earnings forecasts.

On Tuesday, the S&P 500 .SPX, Wall Street's benchmark index, lost 2.6 percent while global stocks, as measured by MSCI's world equity index .MIWD00000PUS, slipped into negative territory for the year to date. .N

Companies, especially in the West, have spent the better part of the past three years cutting debt and improving their profit margins. With the second quarter U.S. earnings season so far showing eight in 10 companies in the S&P 500 meeting or beating estimates, the profit outlook may hold up and margins may even improve further.

"With so many heightened risks right now in the market and so many of them coming from policymakers' comments, the markets are climbing a wall of worry," said Adrian Foster, head of financial markets research, Asia Pacific at Rabobank International in Hong Kong.

"Yet we think that businesses had already battened down their hatches and earnings look reasonably good. So if anything, the risks out there will cause companies to cut costs further."

DEBT CRISIS

Investors who had initially cheered a deal in Washington to raise the debt ceiling quickly realized that the spending cuts called for under the plan would place a fiscal drag on an already struggling economy.

Europe's sovereign debt crisis also contributed to the gloom -- Italian bond yields hit their highest in the euro's 11-year lifetime on Tuesday.

Italy and Spain have been under increased pressure in recent weeks due to concerns that the euro zone's bailout fund is too small to protect larger peripheral economies if the contagion from the Greek crisis cannot be contained.

"The implications for the Italian market and economy going through something similar to Greece is pretty frightening. People are suggesting it's not bailout-able," said Justin Gallagher, head of Sydney sales trading at RBS.

The gloom sent investors scurrying toward assets seen as offering safety in times of financial turbulence.

The Swiss franc traded around 0.7670 after rocketing to a record high around 0.7610 per dollar on Tuesday, but commodity-linked currencies such as the Australian dollar slipped as investors shed riskier assets.

The euro lost ground against the dollar, trading around $1.4200, after falling as low as $1.4149.

"It is abundantly clear that market participants have little confidence in the success of the patchwork of solutions that have been discussed by euro zone policymakers thus far," said Samarjit Shankar, managing director of global foreign exchange strategy at BNY Mellon.

Traditional safe haven gold touched a record high at $1,661.14 an ounce, while oil, demand for which is influenced by growth expectations, slipped around 0.6 percent.

Japanese government debt, another safe haven, was in demand, with 10-year futures rising 0.24 point to 142.16, the highest since November, while the benchmark 10-year yield slipped 2.5 basis points to 1.015 percent.

(Additional reporting by Hideyuki Sano in Tokyo, Ian Chua in Sydney, Kevin Plumberg and Manolo Serapio Jr in Singapore and Ju-min Park in Seoul; Editing by Ramya Venugopal)

Moody's Investors Service and Fitch Ratings maintained U.S. ratings for now, but said additional deficit-reduction measures are needed for the government to put its finances in order and retain the coveted rating.

Underscoring that threat, Moody's assigned a negative outlook to the Aaa rating, which means a downgrade is possible in the next 12 to 18 months.

Fitch promised to conclude a more thorough review of the United States by the end of the month and did not rule out slapping a negative outlook on the rating.

Now investors await Standard & Poor's. The agency has been tougher than its rivals, threatening to downgrade U.S. ratings by mid-October if lawmakers did not come up with a plan to meaningfully cut the budget deficit.

The actual plan approved in Washington called for budget savings of $2.1 trillion in the next 10 years, nearly half the amount S&P has said would be enough to support the AAA rating.

"If they stick to what they said, they would downgrade (the United States). But I suspect they are under tremendous pressure not to do so," said Mohamed El-Erian, co-chief investment officer at PIMCO.

Lingering anxiety about a possible U.S. downgrade contributed to the poor performance of U.S. stocks on Tuesday, adding to worries about the economy. The S&P 500 turned negative for the year after closing in the red for a seventh day. In Tokyo, the Nikkei average fell more than 2 percent.

ECONOMIC CONCERNS

Both Moody's and Fitch have expressed heightened concern about the performance of the U.S. economy, which is crucial for the efforts of stabilizing the country's debt ratios.

The U.S. economy stumbled badly in the first half of 2011, coming close to contraction in the first quarter. It expanded just 0.4 percent in the first quarter, a sharp downward revision from the previously reported 1.9 percent gain, and rose 1.3 percent in the second quarter.

"The downward revisions of the GDP were bigger than we expected and a source of concern," David Riley, Fitch's top analyst for the United States, told Reuters in an interview.

For Moody's, that economic performance may be just an adjustment period, or may be a sign that the financial crisis permanently damaged the growth potential of the United States.

"We would expect that growth would accelerate in 2012 from the first half of the year," Steven Hess, Moody's top analyst for the United States, said.

"But if it doesn't, that means that the whole process of fiscal consolidation and the plans to achieve lower deficits and lower debt ratios will be made all the more difficult."

Another issue that will be closely monitored by Moody's is the evolution of U.S. borrowing costs in the next few years.

The agency would see it as normal if yields paid on U.S. 10-year Treasury notes rise from the currently "abnormal level" of around 2.6 percent to near 4 percent by 2012 and almost 5 percent by 2016, Hess said, referring to the economic assumptions of the Congressional Budget Office.

DEFICIT REDUCTION

The main difference between Standard & Poor's and its rivals is that S&P has said a meaningful deficit reduction deal, if not agreed now, would be even more difficult in 2012, when presidential elections are likely to increase political divisions in Washington.

Moody's and Fitch seem to be more flexible with that time horizon and willing to give the lawmakers the benefit of the doubt.

The plan just approved in Washington includes initial savings of $917 billion and another $1.5 billion by the end of the year, based on recommendations of a bipartisan joint House and Senate committee. Automatic across-the-board spending cuts would kick in if this mechanism fails.

However, Moody's stressed the new framework is "untested."

"Attempts at fiscal rules in the past have not always stood the test of time," the ratings agency said in a statement. "Therefore, should the new mechanism put in place by the Budget Control Act prove ineffective, this could affect the rating negatively."

(Editing by Richard Borsuk)

Moody's negative outlook is a sign that a downgrade is still possible in the next 12 to 18 months.

The ratings agency affirmed the United States' Aaa rating after Congress agreed to raise the country's debt ceiling, which will allow the Treasury to keep servicing U.S. debt obligations.

Moody's had placed U.S. ratings on review for a possible downgrade on July 13, fearing that the government could miss debt payments if lawmakers failed to increase the country's legal borrowing limit by early August.

"Today's agreement is a first step toward achieving the long-term fiscal consolidation needed to maintain the U.S. government debt metrics within Aaa parameters over the long run," Moody's said in a statement.

With the debt ceiling issue resolved, the agency said it is focusing on the long-term challenges to U.S. public finances, burdened by a deficit that has reached about 9 percent of the country's economy -- close to the highest since World War II.

Moody's said that while the combination of the law's congressional committee process and automatic triggers provides a mechanism to induce fiscal discipline, this framework is untested.

"They are simply saying they are waiting to see what develops with the new deficit budget commission. It is certainly reasonable given the U.S.'s fiscal position," said John Silvia, chief economist at Wells Fargo Securities in Charlotte, North Carolina. "Now that we are past the deficit issue, the fiscal issues over the long run will be the story."

The Senate on Tuesday approved the $2.1 trillion deficit-reduction plan by a 74 to 26 vote and President Obama signed it into law.

The law lifts the debt ceiling enough to last beyond the November 2012 elections, calls for $2.1 trillion in spending cuts spread over 10 years and creates a bipartisan joint House and Senate committee to recommend a deficit-reduction package by late November. It does not include any tax increases.

(Reporting by Walter Brandimarte and Daniel Bases; Editing by Dan Grebler)