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Spain’s recession deepened in the three months through June as the toughest budget cuts in the country’s democratic history pushed the economy into a third consecutive quarter of contraction, the Bank of Spain said.

The euro area’s fourth-largest economy shrank 0.4 percent from the first quarter, when gross domestic product fell 0.3 percent, the central bank said in an estimate in its monthly bulletin released in Madrid today. Domestic demand “fell more sharply than in the prior quarter,” while exports showed a “moderate recovery,” it said.

Prime Minister Mariano Rajoy last week announced his fourth round of tax increases and spending cuts since Dec. 30 as he struggles to convince investors that the nation won’t need a second bailout. The planned budget cuts through 2014 now amount to more than 10 percent of annual GDP. Spain’s 10-year note yields surged above 7.5 percent today, breaching a level that forced Ireland, Portugal and Greece to seek external aid.

“Confidence suffered further following the latest Spanish news over the past couple of days,” said Christian Melzer, an economist at Dekabank in Frankfurt. “We don’t see the breakup of the euro, but whether the euro region will still be the same in terms of members over the next two years is unclear. We don’t expect Spain to leave; the latest austerity measures are definitely a positive step for the nation.”

Benchmark Bond

The yield on Spain’s 10-year benchmark bond surged 26 basis points to 7.57 percent today. The spread with similar German maturities widened to 6.42 percentage points.

The euro dropped for a fourth straight day against the U.S. dollar, trading at $1.2119 at 12:39 p.m. in Frankfurt and falling below its lifetime average against the dollar. The European currency has declined 3.9 percent over the past two months, reflecting investor concern about the worsening turmoil.

European leaders failed to stem the euro’s decline with the approval of a 100 billion-euro ($122 billion) aid package for Spain last week. With Spain’s regions confronting about 15 billion euros of debt redemptions in the second half of this year, Catalonia, Spain’s most indebted region, followed Valencia in saying it will examine conditions of a central government aid mechanism.

Italian Prime Minister Mario Monti, whose country also is burdened with surging borrowing costs, said last week that unrest in Spain, where protesters opposed the government’s new austerity package, added to euro concerns. In Greece, officials have been struggling to stand by obligations tied to 240 billion euros of rescue funding over the past two years.

Government Debt

Euro-area government debt increased to 88.2 percent of GDP in the first quarter from 87.2 percent in the previous three months, the European Union’s statistics office in Luxembourg said today. That’s the highest since the euro was introduced in 1999. At 132.4 percent of GDP, Greece had the highest debt burden, with Spain’s debt increasing to 72.1 percent from 68.5 percent. Italy’s debt was at 123.3 percent.

Spain’s economy probably contracted 1 percent in the second quarter from a year earlier, today’s report showed. Domestic demand declined 1.2 percent from the previous three months, when it fell 0.5 percent, the Bank of Spain said. As job losses continued, households ate into their savings and low disposable income reduced their ability to pay down debt, it said.

The decline in tax receipts pointed to the risk the government may miss its budget goals even as a 65-billion euro austerity package announced earlier this month should help it approach the new budget targets, the Bank of Spain said.

Austerity Package

Rajoy’s fourth austerity package in seven months will raise the sales levy to 21 percent from 18 percent; scrap a tax rebate for home buyers; scale back unemployment benefits and study pension cuts; and eliminate the year-end bonus for public workers. The budget measures, covering the next two-and-a-half years, are about double those previously announced.

The Bank of Spain said today that the reduction in labor costs isn’t enough to restore competitiveness even as net exports contributed more to the economy in the second quarter than in the previous three months.

“Given that most of the measures will take place at the end of the year, it shows that the worst is still to come,” said Ricardo Santos, an economist at BNP Paribas SA in London.

Spain’s economy may struggle to emerge from a slump as the euro area is edging toward a recession. The 17-nation bloc’s services and manufacturing industries probably continued to shrink in July, a Bloomberg News survey shows ahead of tomorrow’s release. In Germany, Europe’s largest economy, investor confidence dropped for a third month in July.

Japan, China

The International Monetary Fund said earlier this month that the euro-area economy may shrink 0.3 percent this year before expanding 0.7 percent in 2013. That compares with the European Central Bank’s June forecasts of a contraction of about 0.1 percent this year.

Elsewhere in the world, economies are also cooling. China’s economic outlook was cut by Japan, its biggest Asian trading partner, as the Shanghai Composite Index fell to its lowest level in three years on concern about faltering domestic demand and export growth.

“The slowdown in the global economy is becoming more widespread,” the Cabinet Office said in a monthly report in Tokyo today. Japan’s government said the expansion in China is “slowing a bit,” lowering its evaluation for a third month.

The European Commission is scheduled to publish an initial estimate for euro-area consumer confidence in July at 4 p.m. in Brussels today.

(For more on the euro-area crisis, see TOP CRIS.)