Fear over European debt surged Monday and drove stocks lower around the world.

The S&P/TSX composite index closed down 77.37 points at 11,545.54 after the yield on Spain's benchmark 10-year bond surged to 7.56 per cent. Earlier, it was down by as much as 206 points.

If Spain's borrowing rates continue to rise then Spain may end up being locked out of international markets and be forced to seek a financial rescue.

The Canadian dollar closed down 0.40 of a cent at 98.35 cents US.

The Dow Jones industrial average was down 101.11 points at 12,721.46, after earlier losing almost 240.

The price of crude oil for September delivery closed down $3.69 at $88.14 US US a barrel, and yields for U.S. government bonds sank to record lows, a sign that traders were seeking the safety of American debt.

The euro hit a two-year low against the U.S. dollar. The euro slipped by 0.20 per cent, to $1.21 US, its lowest reading since June 2010.

Spain's economy shrinks 0.4%

The Bank of Spain said the Spanish economy contracted by a quarterly rate of 0.4 per cent in the second quarter.

Falling economic output makes it even more difficult for Spain to deal with its debts. An eastern region of Spain said last week that it would need a bailout from the government in Madrid, and a southern region said over the weekend that it might also need help.

Spain's market regulator said it was temporarily banning short-selling of shares on its stock indexes. In a short sale, an investor seeks a profit by betting that the price of a certain stock will fall.

Strong selling rattled European markets.

The main stock index dropped more than seven per cent in Greece, one per cent in Spain, three per cent in Germany and two per cent in Britain.

The Dow has had only four declines of 200 points this year, including its worst, a 274-point drop on June 1. The Standard & Poor's 500 index fell 12.14 points at 1,350.52, and the Nasdaq composite index was lower by 35.15 points to 2,890.15.

"The list of weakening overseas markets is getting longer by the day," said Lawrence Creatura, a porfolio manager at Federated Investors, a mutual fund firm.

China's slowing activity also concerned traders. A forecast from a Chinese central bank adviser that China's economy could grow at a slower pace in the third quarter deepened concerns about the global slowdown.

With files from The Canadian Press