Moody's three-step downgrade of Spain has pushed the euro lower but it still managed to end the day with a gain on the dollar.
The downgrade has come about as Madrid takes on another €100bn in debt from the European Union's emergency fund to rescue its banks.
Earlier, Spain's government insisted that a vast euro zone rescue loan for its banks comes with no new strings related to austerity or broader economic reforms.
Facing parliamentary questions over the loan of up €100 billion to salvage the banks, Economy Minister Luis de Guindos denied it imposed new conditions beyond the financial sector.
Loan conditions would be specific to the banking sector with no requirement for a broader austerity programme, he told parliament.
"I insist there are no supplementary conditions on budget policy, nor structural reforms," he said.
There would be no new recommendations beyond those made by the European Commission on May 30 as part of its monitoring of Spain for exceeding agreed public deficit limits, the minister said.
European Union economic and finance chiefs would decide on those recommendations "soon", he said. Prime Minister Mariano Rajoy stressed that banks would have to repay the money.
"It is a credit for the banking system that the banking system itself will have to pay, and we should celebrate the fact that our European partners have helped us," he told parliament.
Spain urged ECB to take urgent action in crisis
Spain's Prime Minister Mariano Rajoy called for the European Central Bank to intervene urgently to calm financial markets in a letter dated June 6 and released today.
Rajoy wrote the letter to European Union president Herman van Rompuy and European Commission chief Jose Manuel Barroso three days before the euro zone agreed a vast rescue loan for Spain's banks.
"Given the deep-seated doubts about the euro, the speed of financial markets and the flight of liquidity from the periphery to the centre, we need to act with urgency to stabilise financial markets and lower risk premiums," he said.
"Businesses and households need access to liquidity. That is impossible if doubts persist over the sustainability of the debt of sovereign states," Rajoy warned.
Europe needed the necessary instruments to calm market fears, the prime minister added.
"Today, the only institution we have with the capacity to assure the required conditions of stability and liquidity is the European Central Bank," the Spanish leader said.
"Assuring financial stability is, at this time, essential to show the commitment of member states to the irreversible nature of the euro," he cautioned.
Spanish bond rates dip, but remain high
The rate of return demanded by investors for Spanish and Italian 10-year bonds eased slightly today but remained near record high levels as the rate for Germany rose.
The yield on benchmark Spanish 10-year bonds dipped to 6.613% by mid-morning from 6.651% at yesterday's close, remaining close to a record high level of 6.678% reached at one stage yesterday.
Italian bond yields fell to 6.089% from 6.156% yesterday.
Analysts said that despite today's falls, the two countries are facing very high rates which seem untenable for the long-term.
Spanish and Italian borrowing costs have soared on a market beset by doubts over a vast rescue loan for the Spain's banks and by fears of a Greek exit from the euro zone.
Even German yields have suffered from the market doubts on the immediate future of the euro zone. The rate of return on German 10-year bonds rose to 1.503%, from 1.423% last night night.
Adding to Spanish agony, Fitch Ratings yesterday downgraded 18 more Spanish banks a day after cutting its ratings on the two biggest banks, Santander and BBVA, despite the massive sector bailout.
Far from calming the markets, the rescue for Spain exposed a string of new doubts over the impact on the debt; how it will be implemented; and whether it will be just the first rescue for a nation struggling to cut deficits in a period of recession and sky-high unemployment.
Spain is expected formally to seek the loan at a euro zone finance ministers' meeting June 21, and a final figure would come after a review by the European Union, European Central Bank and IMF, officials said.
And tiny Cyprus has added to the gloom. Cyprus Finance Minister Vassos Shiarly told journalists earlier this week that his country had an "exceptionally urgent" need for a bailout to recapitalise its banks by June 30, according to The Wall Street Journal.
Moody's ratings agency downgraded two Cyprus banks yesterday, citing their large exposure to a possible Greek exit from the euro zone, including chopping its rating for Bank of Cyprus by one notch to B2 from B1.
The big spectre, however, remains Greece, and the prospect that the anti-austerity party Syriza will win elections on Sunday, rejecting the terms of Athens' international bailout and leading possibly to its departure from the 17-nation single currency bloc.
Meanwhile the World Bank yesterday warned developing countries to boost their defences against Europe's debt crisis, predicting years of volatility in a flailing global economy.