Neither the Commission nor Spain's economy ministry would confirm the report in El Pais but Prime Minister Mariano Rajoy said in a radio interview that 2012 would be his country's worst year, to be followed by improvement.

He said Spain would return to growth in 2014, the same year forecast by the Commission according to El Pais, which cited a draft document.

The newspaper reported that the Commission forecasts showed 2013 would be at least as bad as 2012. It saw a 1.5 percent decline in Spanish gross domestic product in 2013 in line with consensus but significantly worse than the 0.5 percent contraction expected by the Spanish government.

The Commission is due to officially announce its autumn economic forecasts on Wednesday, covering growth, inflation, debt and deficit projections.

"In 2014, there'll be growth in Spain. The worst year will have been 2012 and next year will be better," Rajoy said during his radio interview.

The Commission also expects the Spanish economy to grow 2014 but its 0.5 percent growth forecast for that year is far below the 1.2 percent growth forecast by the government, El Pais said.

In 2012, the Commission forecasts the Spanish economy to fall by 1.6 percent this year, slightly worse than the 1.5 percent fall in GDP forecast by Spain.

Economy Minister Luis de Guindos has said he believes the Spanish economy will shrink less this year than the government has forecast after better-than-expected contraction in the third quarter.

HINTS OF DELAY

Rajoy has so far hinted that he can hold off on applying for a financial rescue that would kick-start an ECB bond-buying program and ease financing costs. But the worsening economy may force his hand.

Rajoy reiterated on Tuesday the government was still studying the conditions which would be applied to Spain if it were to request aid, but said the biggest question was whether a bond-buying program would reduce financing costs.

Any request for economic aid would clear the European Central to activate a plan to buy Spanish debt in the secondary market in an effort to lower the premium the Treasury has to pay to issue debt.

"The problem is not just the conditions, but how much would it reduce the premium? If we end up staying around 400 and doesn't drop to 200 ... well the operation doesn't really make any sense," Rajoy said.

The premium investors demand to hold Spanish over German debt stood at around 435 basis points on Tuesday, a long way below highs of over 650 bps before the ECB announced the plan.

After a year of recession, Spain's unemployment rate hit a record high of 25 percent in the third quarter and its manufacturing sector shrank last month for the 18th consecutive month and at its fastest pace since July.

The Commission also has more negative forecasts for the Spanish budget deficit, predicting a deficit of 8 percent of GDP in 2012, 6 percent in 2013 and 5.8 percent in 2014, including bank recapitalization costs.

Spain is forecasting a deficit of 7.3 percent in 2012, 4.5 percent in 2013 and 2.8 percent in 2014.

The Commission's draft does not include the impact of Spain's latest round of tax hikes, El Pais said.

Spain's key service sector shrank for the 16th straight month in October, a survey showed on Tuesday, showing the economy remains in the doldrums going into the fourth quarter after entering recession in late 2011.

(Reporting By Tracy Rucinski; Editing by Jeremy Gaunt)

• A Permanent Economic Emergency