Asian shares fell for a fourth day in a row and the dollar firmed on Friday as Europe's funding difficulties intensified, with Spanish borrowing costs hitting an unsustainable level and premiums for dollar funds rising further.
In a sign global funding strains may spread to Asia, benchmark three-month euroyen interest rates futures fell to an eight-month low on Friday on concerns that tightness in dollar money markets may prompt non-Japanese banks to raise yen at a higher rate.
Italy has pledged to embark on radical fiscal reforms to pull itself out of the debt crisis, but investor jitters remained firmly in place as euro zone governments struggle to raise funds and banks refrain from lending, seizing up market liquidity.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> fell 1 percent and Japan's Nikkei stock average <.N225> opened down 1.2 percent. <.T>
World stocks, measured by the benchmark MSCI All-Country World index <.MIWD00000PUS>, dropped 1.6 percent on Thursday.
U.S. stocks fell on Thursday as fears over euro zone debt woes overtook more encouraging signs the U.S. economy was improving after data showed a drop in new claims for jobless benefit to a seven-month low last week and a rebound in permits for future home construction in October. <.N>
Despite positive economic data from the U.S., the market is still focused on Europe and its contagion risk, said Hiroichi Nishi, equity general manager at SMBC Nikko Securities.
The U.S. dollar held firm in Asia on Friday, while the euro was resilient, staying above five-week lows of $1.3421 hit on Thursday, with European banks seen repatriating funds back home as signs of funding stress grew.
Euro/dollar three-month cross-currency basis swaps, the cost of swapping euros for dollars, widened by around 6 basis points to -136 basis points on Thursday, the most since the 2008 financial crisis.
Risk aversion dampened sentiment in Asian credit markets, with the spreads on the iTraxx Asia ex-Japan investment grade index widening by 5 basis points on Friday.
Investor commitment to a crucial bailout fund, the European Financial Stability Facility (EFSF), is conditional on improved market sentiment which can only be obtained through troubled countries such as Italy and Greece demonstrating progress in their fiscal reforms.
A lack of confidence the fund can get enough resources to help purchase euro zone paper has aggravated European funding conditions, boosting interbank lending rates and shooting up sovereign debt yields as governments struggle to find buyers at their debt sales.
Euro zone policymakers are aiming to boost the firepower of the EFSF through two options -- insurance against initial losses and a co-investment fund to attract private capital alongside the EFSF -- and are working to finalize the legal and technical details on November 29 and to have the leveraged EFSF ready for operation before Christmas.
The yield premium of Spanish 10-year government bonds over German Bunds hit its highest level since the launch of the euro above 500 basis points after Spain paid an average yield of 6.975 percent on Thursday to sell its bonds, the highest rate since 1997 and just shy of the 7 percent level seen as unsustainable.
Spain faces a parliamentary election on Sunday, putting the country under pressure to quickly reassure markets.
New Italian Prime Minister Mario Monti on Thursday promised rigour and fairness in painful reforms, saying the survival of the euro partly depended on Italy's commitment.
Ten-year Italian bond yields only eased slightly to below 7 percent after reaching 7.259 percent earlier on Thursday.
Commodity prices on Thursday took their steepest tumble since September, with U.S. oil falling back below $100 a barrel, copper slipping 3 percent and silver slumping 7 percent. Gold, normally seen as a safe-haven, shed more than 2 percent.
(Additional reporting by Mari Saito; Editing by Alex Richardson)