Renewed fears about the health of the global economy spooked markets on Tuesday as risks rose that Mexican swine flu may become a pandemic and a newspaper report said U.S. banks may need to raise fresh capital.

The Wall Street Journal said that after stress tests, regulators had told Citigroup Inc and Bank of America Corp that they needed to raise billions of dollars.

The news came as markets were already factoring in a rise in the World Health Organization's pandemic alert to phase 4, indicating the risk of a deadly global outbreak.

Mexican Labor Minister Javier Lozano said the country did not yet plan a mass closure of businesses to try to halt the spread of the disease that has killed up to 149 people.

Economic activity must continue, he said.

But markets were on edge. Most Asian stock markets slipped into negative territory after tentative early gains, and European stock futures prices pointed to a sharp decline when markets there open.

Oil dropped a further 2 percent, sinking below $50 a barrel

on concern that a pandemic would damage the already battered world economy and stifle air travel, and that U.S. banks were still troubled.

The yen climbed to a seven-week high against the euro and a one-month high versus the dollar as investors cut their exposure to riskier currencies.

The Mexican swine flu outbreak came just as many global policymakers were daring to proclaim the start of a tentative turnaround in the world economy after months of decline.

Now, any recovery is in doubt.

We almost have to wait to see not so much the contagion aspect but how deadly is this, said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Connecticut.

He said that while a mild strain would have only a limited global impact, if you start getting a number of fatalities, then it ramps the issue up substantially at every level, from a human standpoint and from an economic standpoint.

Officials at both Citigroup and BofA are objecting to the initial results of the stress tests and planned to respond with detailed rebuttals, the Wall Street Journal reported.

Deutsche Bank, however, announced a leap in first quarter net profit to 1.2 billion euros versus a 141 million euro loss in the same period last year. The results, well ahead of most analyst expectations, were boosted by an almost three-fold increase in revenue from debt trading and sales.

DOWNSIDE RISKS

The World Bank estimated in 2008 that a flu pandemic could cost $3 trillion and result in a nearly 5 percent drop in world gross domestic product.

An outbreak of severe acute respiratory syndrome (SARS) which disrupted travel, trade and workplaces in 2003, cost the Asia Pacific region an estimated $40 billion. It lasted six months and killed 775 of the 8,000 people it infected in 25 countries.

In Washington, the Obama administration said it was too soon to determine the potential economic impact but U.S. Treasury officials were monitoring the situation.

Regardless of the effect of the virus on the global economy, the head of the International Monetary Fund said he did not see a global economic recovery before 2010.

IMF Managing Director Dominique Strauss-Kahn told CNBC television he hoped the worst was over but that green shoots in the global economy were mostly in the United States.

A Reuters survey of analysts across European and the United States taken April 21-27 found a slim majority saying the bottom had yet to be hit in the worst global recession since World War Two. Most expected the crisis to last anywhere from six months to another two years.

Financial and macroeconomic stability are still some way off and we don't yet have the foundation for a solid recovery, said Lena Komileva, chief G7 market economist at Tullett Prebon.

TROUBLED AUTOMAKERS

General Motors Corp, one of the casualties of the global crisis, announced its final plan to stave off bankruptcy on Monday. It aims to slash its $27 billion bond debt through an equity swap and cut more than 21,000 more jobs.

The move would effectively nationalize GM, putting majority control in the hands of the U.S. government -- a controversial issue in a country that has long preached the primacy of markets.

We strongly back an auto industry that we believe can and should be self-reliant, White House spokesman Robert Gibbs told reporters. It is not our desire to either own or run one of the auto companies.

Chrysler lenders were also expected to receive a new offer from the U.S. Treasury shortly. The company has an April 30 deadline to reach a deal with creditors and cement an alliance with Fiat that would eventually give the Italian firm a 35 percent stake in the restructured U.S. automaker.

Japan's Honda Motor also showed the scars of the global slowdown, with an 80 percent drop in annual operating profit. The automaker forecast a savage 95 percent drop in operating profit for the current year to end-March.

(Reporting by Reuters correspondents worldwide; Writing by Andrew Marshall; Editing by Neil Fullick)

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