Global financial markets were rocked by a breaking wave of debt dangers across the globe on Thursday, ranging from the eurozone to the United States and Japan, dealers said.
European stocks fell but the euro clawed back some losses.
Investors are on red alert over the eurozone debt crisis which has already dragged down Greece, Ireland and Portugal all of which were rescued with vast bailouts and is spreading tentacles towards Italy and Spain.
Greece urgently needs the support of a second rescue package.
Moody's ratings agency fired an ominous shot at the United States overnight, warning of a possible downgrade to its top triple-A debt assessment, triggering comment that such a development could trigger a disastrous chain of events.
The warning shot came after agencies downgraded Greek and Irish debt to junk status.
Mounting debt tensions sent gold rocketing to another record high level at $1,594.10 an ounce on the London Bullion Market on Thursday as investors flocked to the safe-haven precious metal.
European equities slid, after a mixed performance in Asia, while the dollar faced heavy selling.
In late morning deals, London's FTSE 100 index fell 1.03 percent to 5,845.73 points, Frankfurt's DAX 30 dipped 0.80 percent to 7,209.43 points and in Paris the CAC 40 lost 1.23 percent to 3,748.04.
Madrid plunged 1.13 percent and the Milan exchange tumbled 1.56 percent in value as the embattled Italian government was forced to accept record rates in a bond auction.
In foreign exchange trading, the European single currency rose to $1.4224 in late morning London deals, after plunging to a four-month low point of $1.3837 earlier this week.
Markets are meanwhile on tenterhooks ahead of Friday's critical results of EU stress tests on Europe's troubled banking sector.
"The sovereign debt crisis may have originated from Greece, but it is now spreading its tentacles throughout the western world," Forex.com research director Kathleen Brooks told AFP.
"For too long falsely benign conditions meant that countries in the West could amass huge amounts of debt. But now the market's view has changed. Huge debt-to-GDP ratios will no longer be tolerated, even in large economies like Italy.
"Rising bond yields are the markets' way of telling governments to get their fiscal houses in order," she added.
Italy's Treasury was forced on Thursday to issue bonds at sharply higher rates amid volatility on financial markets worried that the country could get dragged down by Europe's deepening debt crisis.
The auction raised 3.0 billion euros ($4.3 billion) in bonds due between 2016 and 2026 but the rates were at record levels, the central bank said.
The Italian Senate is set to give its initial approval to sweeping austerity measures later on Thursday aimed at balancing Italy's budget by 2014.
US President Barack Obama clashed with a top Republican foe in tense talks to avert a ruinous August US debt default, which Federal Reserve chairman Ben Bernanke said would be a "major crisis" for the world's biggest economy.
China, which is by far the top holder of US debt, with holdings at $1.153 trillion, has urged Washington to protect the interests of investors.
In Europe, Fitch became the last of the three global agencies to demote Greek bonds to junk status on Thursday. The agency has cut Greece's status by three notches to CCC status from its previous rating of B+.
The move came because of the absence of a new European Union-International Monetary Fund programme for Greece and growing uncertainty of the role private investors would play in any bail-out, said the agency.
The IMF, meanwhile, said Greece would need another 104 billion euros (148 billion dollars) in aid with almost a third of the money coming from private creditors an issue that has caused a deep rift between European leaders.
"We are in the midst of what could be a large re-pricing of sovereign risks," said analyst Brooks.
"This will affect all western economies, not just peripheral Europe, but the UK, the US and Japan as well.
"All of these countries have large public debts and aging populations that will increase long-term public liabilities.
"If we are to avoid a full-blown debt crisis the authorities' need to act now, credit markets will no longer tolerate inaction," she added.