World stocks and oil prices fell on Thursday as a rise in Spain's borrowing costs to almost 7 percent at an auction fed fears that the euro-zone debt crisis could spread further.

The euro erased most of its gains in early afternoon and U.S. Treasury debt prices reversed losses as a drop-off in risk appetite drove investors to seek safety.

A pledge by Italy's new prime minister, Mario Monti, of additional economic reforms earlier had helped drive up the euro against the dollar. In his maiden speech before an evening confidence vote, Monti outlined a broad raft of policy priorities, including pension and labour market reform, a crackdown on tax evasion and changes to the tax system.

But his speech failed to quell worries about the future of the euro zone, and a rise in Spain's borrowing costs to nearly 7 percent at an auction fuelled investors' anxiety.

A decline in first-time claims for U.S. benefits to a seven-month low added to hopes that the economy may be in better shape than some had believed, but in the markets that positive news was trumped by the worries over Europe.

You can focus on the good data here, the corporate data, the economic data saying we are not in a recession, said John Canally, an investment strategist and economist for LPL Financial in Boston. But at the end of the day, bond yields in Europe will rule.

Key Wall Street stock indexes fell more than 1 percent, with the Nasdaq slumping more than 2 percent.

The Dow Jones industrial average <.DJI> fell 121.05 points, or 1.02 percent, to 11,784.54, while the Standard & Poor's 500 Index <.SPX> lost 17.67 points, or 1.43 percent, at 1,219.24. The Nasdaq Composite Index <.IXIC> was down 56.33 points, or 2.13 percent, at 2,583.28.

In Europe, the FTSEurofirst 300 <.FTEU3> index slid 1.3 percent to close at 957.85 points after falling to a more than one-month low of 950.94. Banking shares, which have slumped more than 35 percent so far this year due to their huge exposure to euro zone sovereign debt, were among the top decliners.

World stocks, measured by the benchmark MSCI All-Country World index, dropped 1.4 percent.

The euro was practically flat against the dollar at $1.347 after having risen around half a percentage point earlier.

The Spanish auction was really bad and yields are rising to levels where there are expectations that fresh margin calls will be imposed, said Nomura currency analyst Geoff Kendrick. The only way to trade euro is to sell. It is headed lower and our year-end target of $1.30 looks to be tested soon.

Yields paid on 10-year Italian bonds were at 6.86 percent after reaching 7.259 percent earlier in the session. Spanish 10-year bonds were paying 6.5 percent.

The benchmark 10-year U.S. Treasury note erased early losses to gain 8/32 in price, with the yield at 1.972 percent.

U.S. crude oil prices fell 3.28 percent to $99.23 per barrel.

(Reporting and writing by Walter Brandimarte; Additional reporting by Chuck Mikolajczak; Editing by Leslie Adler)