* Euro extends losses, hits record low vs Swiss franc
* EUR/USD hits 4-month low on fear of euro zone contagion
* Volatile trading likely to persist, traders say (Updates prices, adds quotes, graphics links)
By Julie Haviv
NEW YORK, July 12 (Reuters) - The euro slid to its lowest level against the dollar in four months and hit another record low against the Swiss franc on Tuesday on fears that leaders in the euro zone are failing to stop a debt crisis from spreading.
Borrowing costs for Italy and Spain soared to 14-year highs earlier in the session as euro zone leaders conceded for the first time that Greece may have to default on some of its debt. See [ID:nL6E7IC097]
Italian 10-year bond yields later fell below 6 percent on market talk the European Central Bank was buying Italian and Spanish bonds. [ID:nL6E7IC260]
Investors fear a Greece default could ripple through Europe's banking system, putting pressure on stretched public finances in other euro zone countries. Italy, the euro zone's third largest economy, looks especially vulnerable: its debt-to-output ratio is second only to Greece, and markets fear political bickering may derail a plan to slash spending and rein in the deficit.
"The power of the market to force the problems associated with contagion to the surface are clear today," said Camilla Sutton, chief currency strategist at Scotia Capital in Toronto.
The euro fell as low as $1.3835
Plans for an emergency summit of policymakers on Friday to discuss the debt crisis also helped the euro recoup some of its losses, traders said.
Sutton said fears over Spain and Italy are understandable but not totally justified.
While Spain has a fiscal balance problem, it does not have a debt problem, with a relatively small gross debt position of 64 percent of GDP. Italy, on the other hand, has a debt problem with a concerning gross debt of 120 percent of GDP, she said.
"The more important complications for Spain and Italy are their ability to grow in the current environment, exposure to the periphery and political tensions."
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Euro zone pledges new steps to help Greece:[ID:nL6E7IB1PQ]
Italy dragged into eurozone crisis: [ID:nLDE76A0EA]
Graphic on Italy with other 'debt-heavy' EU countries
http://r.reuters.com/cuz52s
Italy debt/deficit comparison http://r.reuters.com/baz52s
Euro zone bond yields http://r.reuters.com/saz52s
Sovereign credit ratings: http://r.reuters.com/vyc22s
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
The euro fell to a record low against the Swiss franc for a second straight day
YEN GAINS, US DEBT DEBATE IN BACKGROUND
The yen, also considered a shelter from the storm, rose broadly, The dollar fell 0.9 percent to 79.52 yen, near its lowest since March. The euro shed 1.1 percent to 111.34 yen.
Sentiment toward the euro could change if the EU adopts what Steven Englander, head of G10 FX strategy at Citigroup, termed "the big bazooka approach" -- a blanket guarantee on peripheral countries' debt, aggressive ECB buying of euro zone debt or a plan to create a common euro zone bond.
"It is likely that if one of these 'big' solutions is adopted, we would see the euro rally initially and perhaps sharply," he said. But "the question would be whether such proposals would be credible if Italy and Spain were under sustained pressure, since the potential sums would be extremely large and political opposition in the core far from trivial."
If the EU can calm markets, analysts said the focus could shift to the dollar and the U.S. debt ceiling. The U.S. Treasury Department has warned it may have to default on some debt if lawmakers don't agree to lift the legal U.S. borrowing limit by Aug. 2. (Additional reporting by Steven C. Johnson in New York and Naomi Tajitsui in London; Editing by Padraic Cassidy)