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LONDON (AFP) – The euro and European stocks rallied strongly on Wednesday and pressure on Spain eased, but the eurozone debt crisis weighed heavily with a credit watch for Portugal and Germany struggling to sell bonds.

Leading EU figures warned that financial markets were underestimating the will of EU leaders and institutions to defend the euro and the eurozone.

But in a new sign of the extent of anxiety among investors, a German bond issue was undersubscribed.

"Markets are still concerned about the debt crisis spreading to other countries," said Commerzbank analyst Ulrich Leuchtmann.

The euro shot above 1.31 dollars in trading here, a day after hitting a two-month low point under 1.30 dollars. The Madrid stock market meanwhile surged more than 3.0 percent in early afternoon trading.

"For all of the woes around at the moment the equity markets continue to be reasonably solid," said Simon Denham, head of trading group Capital Spreads.

Overnight, ratings agency Standard & Poor's placed Portugal on a credit watch because of "increased risks to the government's creditworthiness".

S&P on Tuesday said increased risks came from the Portuguese government not doing enough to enact "growth-enhancing reforms" and from proposed changes to EU rules that could mean private bondholders are last in line to be paid back.

Fears that Portugal could follow Ireland and Greece in receive a massive international financial bailout had sent the euro sinking on Tuesday.

However the single currency recovered on Wednesday, standing at 1.3105 dollars from 1.2983 dollars late on Tuesday in New York.

"The euro has stabilised overnight following comments from ECB President (Jean-Claude) Trichet hinting that the ECB could consider expanding its sovereign debt purchase programme," said Lee Hardman, analyst at The Bank of Tokyo-Mitsubishi UFJ in London.

European Union bailout chief Klaus Regling and France's Finance Minister Christine Lagarde meanwhile each stressed on Wednesday that the EU was focused on protecting the euro.

Their strong statements came as leading European stock markets rallied, with London jumping 1.45 percent, Frankfurt up 1.76 percent and Paris gaining 1.0 percent.

Stock prices in Madrid shot up 3.11 percent and share prices also climbed in Italy and Portugal.

The 10-year borrowing rate for Spain eased to 5.30 percent having reached 5.50 percent on Tuesday, and the difference above the rate Germany must pay fell to 2.60 percentage points from 3.0 on Tuesday. The Spanish government announced a new wave of privatisations.

However in eurozone benchmark Germany, the agency which manages the country's sovereign debt received offers for just 4.55 billion euros after tendering five-year bonds worth a total of 5.0 billion euros.

Analysts meanwhile noted that the intention of the European Central Bank to edge back towards normal monetary policies when its governing council meets on Thursday may have been blown off course by the Irish debt crisis.

When the Greek crisis caused lending markets markets to freeze up in April the ECB began providing banks with unlimited short-term loans at low rates.

As lending markets in most of the eurozone countries have returned to normal, the ECB has begun to look for an "exit strategy" to end its exceptional measures to support the banking system, but the Irish crisis has reawakened concerns.

"The ECB will need to continue to provide exceptional support, despite earlier indications," ABN-Amro analysts said in a research note.

In taking on problems faced by major Irish banks, Dublin dug itself a hole that forced it last week to seek 67.5 billion euros (88 billion dollars) in financial aid from the European Union and the International Monetary Fund.

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