Portugal's financial plight deepened today with borrowing rates jumping higher and stocks slumping after its bonds were downgraded to junk status.
Spain and Italy were dragged into the downturn, adding new momentum to Europe's sovereign debt crisis.
Portugal's hopes of slowly emerging from its debt crisis were knocked by ratings agency Moody's, which downgraded Portugal's debt four notches and said the country will probably follow Greece in needing a second rescue package.
After the abrupt worsening of Portugal's financial situation, neighbouring Spain immediately suffered a knock-on effect, with Madrid's main stock index down and bond yields up. Spain, a much bigger country, until now has managed to dodge major fallout from the continent's fiscal woes.
The jitters were even felt in Italy, where stocks were down on concerns that spending cuts might not be enough to bring down high debt.
The idea that the crisis might grow to engulf larger economies is a looming threat for markets. Rescuing Spain and Italy would be many times more expensive than all the bailouts the EU has paid for so far.
"The increasing risk is Italy gets caught up further in the contagion, and the bond market vigilantes dictate a more abrupt pace for its adjustment," said Alan Ruskin, an analyst at Deutsche Bank.
The Moody's downgrade - viewed by some analysts and officials as unexpectedly harsh - triggered new outrage in Portugal, where austerity measures over the past year have included tax hikes, pay freezes and welfare cuts.
Portuguese Prime Minister Pedro Passos Coelho said the downgrade was "like a punch in the stomach." Fernando Faria de Oliveira, the head of Portugal's largest bank, the state-owned Caixa Geral de Depositos, called it "immoral and insulting."Reuse content