Spain's increasingly desperate struggle to put its finances right have seen its borrowing costs soar to levels that are seen as being unsustainable. Italy, commonly regarded as too big to bail out, has been dragged along in its wake.

The Spanish Treasury raised 3.04 billion euros ($3.7 billion) of 3-, and 6-month T-bills, meeting its target. The average yield on the 3-month bill was 2.434 percent, up from 2.362 in June. For the six-month paper, the yield jumped to 3.691 percent from 3.237 percent last month.

On the secondary market, Spanish five-year government bond yields rose above 10-year yields for the first time since June 2001. Having to pay more to borrow shorter-term rather than longer-term is usually a sign that markets think the risk of a default or debt restructuring has increased.

"The spread between 5- and 10-years moved to negative today, which is a classic sign that the market thinks the current trends are unsustainable for Spain's fiscal dynamics," said Nick Stamenkovic, bond strategist at RIA Capital Markets.

On Friday, the government said it expected the economy to remain in recession well into next year while the autonomous region of Valencia became the first to ask Madrid for aid to pay debt obligations it cannot meet. Others are expected to follow suit.

It has already asked for up to 100 billion euros to recapitalize its ailing banks which have been battered by the four year economic downturn and a burst property bubble which has sent mortgages falling every month since August 2007.

The alarming spiral of Spain's debt costs has banished any hopes that a bailout of its banks, or a June EU summit which gave the euro zone's rescue funds a green light to intervene in the markets, has put the debt crisis in abeyance.

Spain and Italy have called on their partners or the European Central Bank to help ward off market pressure, although Italian premier Mario Monti said on Monday the ECB did not have to leap into action just yet.

Although it has cut interest rates, the ECB has shown marked reluctance to revive its bond-buying programme, the only mechanism that could directly lower borrowing costs.

French Foreign Minister Laurent Fabius said on Tuesday that further aid for Spain could take the form of an increase in Europe's rescue fund or action by the ECB.

"I hope it will not be necessary to intervene again," he told France 2 television. "If we have to intervene, it could be an increase in the firewalls ... or interventions by the (European) central bank."

The premium investors demand to hold Spanish 10-year bonds jumped to its highest level since the birth of the monetary union, at 7.6 percent, on Monday while the cost of insuring Spanish debt from default also hit record highs.

Ten-year yields of over 7 percent have triggered spiraling debt costs in other European economies which have eventually led to bailouts, though Spain's Economy Minister Luis de Guindos reiterated on Monday Madrid would not need more aid.

(Additional reporting by Manuel Ruiz; Writing by Mike Peacock; editing by Anna Willard)

• A Permanent Economic Emergency