Earlier Friday, finance ministers from the 17 countries that use the euro unanimously approved the terms for a bailout loan for Spain's banks, which have been struggling under the weight of toxic loans and assets from the collapse of the country's property market.
Investors have been fighting shy of Spain for months, worried that the country could not keep control of its deficit during a recession while supporting its stricken financial sector.
Spain is the 17-country eurozone's fourth-biggest economy and many market-watchers fear that if it asked for a bailout, the rest of the region could not afford to foot the bill. The country and its banks were also locked in a vicious debt spiral, where the shaky banking system has been propped up by the indebted government so that the banks could buy more government debt. The loan facility agreed to on Friday was designed to break that spiral.
The bank agreement came as Spain cut its growth forecast and one of the country's heavily indebted regions asked for help. The news sent the country's borrowing costs soaring and its stock prices plummeting. In afternoon trading, Spain's main IBEX index was down almost 6 per cent while the interest rate on the country's 10-year bond — an indicator of investor confidence in a country's ability to manage its debt — was at 7.2 per cent. This is a rate that many market-watchers consider is too high a price for a country to pay in the long term.
Treasury Minister Cristobal Montoro on Friday forecast Spain's recession will drag on into 2013, although the economy will not be quite as weak as it now. According to the latest figures, the country's gross domestic product is expected to contract 0.5 per cent in 2013, compared with the previous forecast for it to grow by 0.2 per cent.
Unemployment, which is now at 24.4 per cent, will remain about the same next year, Montoro said.
Meanwhile, the economy will shrink 1.5 per cent this year, a slight improvement from the 1.7 per cent drop previously predicted, he added.
Also Friday, the region of Valencia that it would become the first to tap a fund designed to help out Spain's 17 semi-autonomous regions. Many Spanish regions are so heavily in debt — due to overspending and the burst real estate bubble — that they cannot raise money at affordable rates. As a result, they are struggling to repay creditors and settle contract bills.
The fund for the regions was created only last Friday and will have €18 billion ($22 billion) in capital. A third of that is a loan from the state-owned company that runs Spain's many lotteries.
The government this week passed painful austerity measures — tax hikes and cuts to benefits, salaries and pensions — to reduce state debt and strengthen confidence in its finances.
Spaniards staged massive anti-austerity protests in 80 cities and towns across the country Thursday night. Police say 15 people were arrested and 39 people injured overnight in central Madrid after tens of thousands of people took part in a demonstration.
Across Europe, markets tumbled on concerns about Spain. In France, the CAC 40 index dropped 2.14 per cent while the German DAX index was off 1.9 per cent. The euro fell to a two-year low of $1.2165.
Here is a round-up of what else is happening around Europe:
Finance ministers from the 17 countries that use the euro unanimously approved the terms for a bailout loan for Spanish banks of up to €100 billion ($122.9 billion).
As part of the deal the "eurogroup" of ministers called Friday for strict monitoring of the banks that receive the aid. It also requires the Spanish government to present this month plans to reduce its budget deficit to under 3 per cent of the country's €1.1 trillion ($1.34 trillion) gross domestic product by 2014.
"The eurogroup is convinced that the reforms attached to this financial agreement will contribute to ensuring a return of all parts of the Spanish banking sector to soundness and stability," the finance ministers said in a statement.
Christine Lagarde, the head of the International Monetary Fund, welcomed the agreement.
"The implementation of these measures will contribute to significantly strengthen Spain's financial system, an essential step in restoring growth and prosperity in the country," she said in a statement.
The agreement, which will be signed in the next few days, calls for an initial disbursement of €30 billion ($36.9 billion) this month. The full amount of money needed to shore up Spain's banks will not be known until September, after individual banks have been assessed.
"The aim of this program is very clear: to provide Spain with healthy, effectively regulated and rigorously supervised banks, capable of nurturing sustainable economic growth," Olli Rehn, the European monetary affairs commissioner said in a statement.
France's corporations and wealthy people were in the line of fire Friday, when the country's lower house of parliament passed a revised 2012 budget on Friday to raise €7.2 billion ($8.8 billion) in new revenue.
The bill, drawn up by President Francois Hollande's Socialists, reverses many of the measures passed under the former conservative president, Nicolas Sarkozy, including: tax breaks on overtime, a lower wealth tax and a reduction in the social charges that employers pay into the state benefit system.
The measures were necessary if Hollande's administration is going to stick to a strict schedule for reducing the deficit while growth continues to slip. The amendments assume the country will grow just 0.3 per cent this year. The Socialists have said they are committed to reducing the deficit to 4.5 per cent of France's gross domestic product this year and 3 per cent next.
France's €2 trillion ($2.4 trillion) economy is the second largest after Germany's among the 17 countries that use the euro.
Italy's Premier Mario Monti admitted Friday that the eurozone debt crisis had spread to Italy and that the country must try to avoid taking a bailout.
He emphasized that Italy does not need further budget measures to raise revenue and shore up public finances.
Monti was asked to form a government late last year after weeks of market turmoil over Italy's stagnant growth and high public debt — which at €1.9 trillion ($2.6 trillion) is nearly 120 per cent of GDP — forced the previous Prime Minister, Silvio Berlusconi out of office.
Italy's borrowing costs have risen steadily in recent weeks due to fears that the government will not be able to handle this high debt load as the country's economy stagnates.
Many of the country's debts are due soon, with Italy having to roll over more than €300 billion ($410 billion) of its debts next year alone. On Friday, the 10-year bond yield was up 0.25 percentage points at 6.15 per cent, while the FTSE MIB stock index dropped 4.38 per cent .
Woolls and Ciaran Giles in Madrid, Sarah Di Lorenzo in Paris and Colleen Barry in Milan contributed to this article.