Spain's sovereign credit rating has been cut by three notches by Spain.
The ratings agency cited ballooning estimates of the cost of a banking crisis, mushrooming debt and a deepening recession.
Fitch's estimated the likely cost of restructuring the banking sector at around €60 billion and possibly as much as €100 billion.
The long-term rating was chopped to BBB from A and left with a negative outlook, said Fitch.
The estimated restructuring cost is more than double Fitch's previous estimate would need €30 billion.
A bank rescue would also push up the state's total accumulated debt at a rapid pace, Fitch said, warning that gross general public debt would likely peak at 95% percent of total economic output in 2015.
Merkel says Europe is ready to act
Chancellor Angela Merkel said Europe was ready to act to ensure stability in the euro zone as Spain's credit rating was cut by three notches amid expectations it may soon seek EU help for banks beset by bad debts.
Spanish Prime Minister Mariano Rajoy said he would wait for the results of independent audits of the banking system before talking with Europe about how to recapitalise troubled lenders.
An IMF report due out next Monday is expected to show Spanish banks need at least €40 billion, financial sector sources said.
Speaking after talks in Berlin with British Prime Minister David Cameron - who called for "urgent action" to tackle the debt crisis, Merkel said Germany stood ready, alongside the other 16 euro zone countries, to do whatever was necessary.
"It is important to stress again that we have created the instruments for support in the euro zone and that Germany is ready to use these instruments whenever it may prove necessary," she said, referring to the euro zone's temporary bailout fund, the EFSF, and to its permanent successor, the ESM.
If Spain does decide to seek help with recapitalising its banks, laden with bad property debts and other underperforming loans, it is expected to ask for funds from the €440 billion euro EFSF or the €500 billion ESM, due to be operational in July.
Spain borrowing hits a level last seen in 1998
Despite the pressure, Spain demonstrated it could still tap credit markets, raising all the money it required, although at a higher cost. Madrid sold €2.1 billion of government bonds, paying just over 6% for 10-year debt - up from 5.74% last month and the highest at auction since 1998.
The sale laid to rest, at least for now, fears raised by Treasury Minister Cristobal Montoro on Tuesday that Spain was being shut out of credit markets.
In the midst of the storm, Spain nominated a new central bank governor, Luis Maria Linde, aiming to restore the Bank of Spain's credibility, battered by its handling of the banking crisis. He was preferred to outgoing European Central Bank executive board member Jose Manuel Gonzalez-Paramo.
Despite a rally in stocks, bonds and the euro owing partly to expectations of action by central banks to revive economic growth, the euro zone remains under pressure to act quickly and decisively to resolve its debt problems.
Investors flock to French bonds
France, the euro zone's number two economy after Germany, continued to benefit from its safe-haven status, selling €7.84 billion of bonds at record low yields despite announcing a partial reversal of the previous government's pension reform on Wednesday that runs counter to EU policies.
US President Barack Obama and Canadian and Japanese leaders telephoned Europe's main leaders this week to express concern at the worsening crisis and press for stronger action, raising hopes before an EU summit on June 28-29.
But Merkel earlier doused expectations that the summit will produce a breakthrough, saying progress towards a fiscal and banking union would take substantially longer.
In a television interview, she said the euro zone was moving inevitably towards a political union requiring nations to cede more sovereignty, and that would lead to more of a multi-speed Europe, with non-euro states in the slow lane.
"I don't believe that there will be one single summit that will decide on a big bang," Merkel told ARD. "But what we have been doing for some time, and on which a working plan will certainly be presented in June, is to say we need more Europe."
"Whoever is in a currency union will have to move closer together. We have to be open to make it possible for everyone to participate. But we cannot stand still because some do not want to go with us," she said.
