The world's economy moved closer to stagnation last month as firms in Asia and Europe reined back in the face of an ongoing debt crisis and signs of a new US
slowdown, business surveys showed on Wednesday.

The euro zone's dominant service sector grew at its weakest pace in nearly two years, Italy's suffered a deepening contraction and Spain's moved into negative territory.

Published the day after a last-gasp deal to avoid a US
default, the surveys followed figures on Monday which painted no brighter a picture for the manufacturing sector.

"Italy and Spain softening is to be expected due to nerves but it makes the fiscal challenge facing them look even more difficult, particularly if we see the numbers stay around these levels for several months," said Victoria Cadman, economist at Investec.

Markets are squarely targeting Italy, the euro zone's third-largest economy, concerned by its weak growth and political instability. Prime Minister Silvio Berlusconi is due to speak to parliament to try and calm fears that have led the country to the edge of a Greek-style financial crisis.

Italy's economy would be too big for the euro zone's existing rescue funds to bail out and the turbulence has caused alarm across the euro zone and beyond.

The 17-nation euro zone's services PMI slid to 51.6 as Germany and France, the continent's two largest economies which had propped up the tepid growth, saw their indexes slip closer to the 50 mark that divides growth from contraction.

Italian service sector activity contracted in July for the second month running and business expectations were the lowest for over two years, while Spain's index fell to 46.5 from 50.2 in June. 

But Britain surprised markets with its service sector growing at a four month high on strong growth in new business while data due at 1400 GMT are expected to show activity in the US service sector likely picked up moderately.      

World stocks tumbled towards five-month lows and top-rated government bonds rallied as worries grew that fiscal cutbacks and stagnating output would prolong a global economic slowdown and aggravate Europe's debt crisis. 

Tuesday's last-minute budget deal to avoid a US default brought only short-term relief as the focus moved to the impact of tighter fiscal policy on the already slowing US economy.

"Disappointing economic data on both sides of the Atlantic, as well as surging Italian and Spanish bond yields, has seen risk appetite plummet as pessimism about the global recovery starts to take hold with a vengeance," CMC Markets analyst Michael Hewson said.

China's fledgling services sector grew in July at its slowest in three months as new orders ebbed, in the latest sign that tight monetary policy is reining in the world's second-biggest economy.

"Service sector activity growth moderated in July, reflecting the effect of monetary tightening and property cooling measures," said Qu Hongbin, an economist at HSBC.  - Reuters