Spain and Portugal take center stage

NEW YORK (CNNMoney.com) -- Worries about the health of some European economies, specifically Spain, Portugal, and Ireland are rearing their ugly head.

And that's put pressure on markets around the globe, with European and Asian stocks selling off on Friday. That sell-off spilled over into the U.S. markets, where stocks were trading lower in an abbreviated session.

Britain's FTSE 100 lost 1.1%, the DAX in Germany dropped 1.0% and France's CAC 40 dipped by 1.5%.

The once-mighty euro is also taking a beating, falling nearly 1% against the U.S. dollar as investors flee for safe-haven assets. The dollar index, which gauges the greenback against a basket of currencies, moved to its highest level in two months.

Meanwhile, yields on Irish government bonds spiked, with the yield on the benchmark 10-year bond breaking the sky-high 9% barrier. By comparison, Spain's 10-year bond yield stands at 5.2%, while Portugal's 10-year sits at 7.2%.

The way the markets are reacting is largely pegged to the outstanding question of timing, said Ken Wattret, an economist with BNP Paribas in London.

"The issue is how long it takes to clarify who gets assistance, and how credible those [bailout] programs are," Wattret said.

Ratings agency Standard & Poor's lowered the credit rating on four Irish banks Friday, one to junk status. S&P questioned the Irish government's ability to prop up the banks as well as the underlying health of the Irish economy.

S&P cut Anglo Irish Bank Corp. to B/B from BBB/A-2, putting the bank's bonds in"junk" or high risk status.

Allied Irish Banks (AIB) and Irish Life and Permanent each had their credit rating cut one notch, to BBB from BBB+. The Bank of Ireland (IRE) was cut one notch from to BBB+ from A-.

"The Irish government's ability to provide further extraordinary support to these banks has weakened," the rating agency said in a statement. "We expect no near-term respite and we believe the prospects for these banks to return to near stand-alone funding profiles in the medium term are receding."

European Commission president Jose Manuel Barroso, a former Portuguese prime minister, denied that Portugal was being pressured by the European Commission to request a bailout, according to media reports Friday.

"It's absolutely, completely false, every reference for an aid plan for this country. It has neither been asked for and neither have we suggested it. It is absolutely false," Barroso said at an Organization for Economic Cooperation and Development conference.

Spain's major banks have a great deal of exposure to Portugal's debt, although the exact amount is not certain. So there are worries that the sovereign debt crisis in Portugal could spill over into Spain.

But Spanish Prime Minister Jose Luis Rodriguez Zapatero ruled out the need for a bailout in a radio interview Friday, saying it was "absolutely" clear it would not be required.

But Wattret said it's not fair to lump Spain and Portugal into the same boat.

Spanish finances are in much better shape, and the economy is much more diversified than that of Greece or Portugal, he said.

Meanwhile, Portugal officially announced Friday that it had adopted austerity measures designed to lower government debt and stabilize the countries financial footing. The country was hit by a widespread strike Wednesday in protest of the looming cuts.

While Portuguese government officials claim they will avoid a bailout, most investors remain "skeptical," Wattret said. "Portugal has a bigger problem in the short run and will require assistance."

Irish officials - who are now in the midst of negotiating a rescue package for their own banking industry - also denied the need for funds for weeks, before finally turning to the International Monetary Fund and European Union for help.

German Chancellor Angela Merkel and French President Nicolas Sarkozy said Thursday they were impressed with the austerity plan Ireland has adopted to tackle its massive debt.

Speaking by telephone, the two leaders also agreed that European Union negotiations with the Irish government must come to a "swift conclusion," according to a statement from Merkel's spokesman.

But a working paper produced by Germany's finance ministry and obtained by the Wall Street Journal paints a different picture - one in which eurozone members, private investors and the International Monetary Fund will be forced into a "permanent, intergovernmental crisis-management mechanism."

Investors have long hoped that a strong central Europe, led by Germany, would retain enough firepower to ward off the debt crisis creeping in the EU's extremities.