Ratings agency Moody's warned Spain on Wednesday that its debt rating could be downgraded, pushing Spain back into the euro zone debt spotlight ahead of an EU leaders' summit starting on Thursday.

Moody's said it was concerned about Spain's high debt funding needs, its heavily indebted banks and its regional finances, but said it did not expect Madrid to have to resort to an EU bailout like Greece and Ireland.

Spain, which with Portugal has come under intense market pressure in recent weeks, raising concerns it could be driven into a bailout, needs to refinance around 60 billion euros of debt early next year, according to JP Morgan research.

Both the cost of insuring Spanish debt against default and yields on its 10-year government bonds rose on Wednesday, an indication of the increased risk attached to Spain.

Spain's Economy Minister Elena Salgado said market movements were being exaggerated by thin volumes at year-end, but said it also made sense to enlarge a European financial rescue fund to make sure it could tackle the crisis.

EU leaders meet in Brussels on Thursday and Friday for their end-of-year summit, with the region's year-long debt crisis and efforts to better tackle it the central issues on their agenda.

As well as approving a change to the EU's treaty demanded by Germany to create a permanent system for handling crises from mid-2013, the leaders will discuss how they can improve the current temporary crisis resolution mechanism -- a 750 billion euro ($1 trillion) joint EU/IMF loan facility.

One possibility is to increase the size of the fund.

Belgian Finance Minister Didier Reynders said the EU's portion, 440 billion euros, could potentially be doubled to fend off the threat of renewed market pressure on Portugal and Spain, and Spain's Salgado backed the idea of a larger fund.

What we think is reasonable is that the real capacity of the fund coincide with the theoretical capacity, she said, pointing out that while it is 440 billion euros in theory, credit guarantees make it smaller than that in practice.

DEFENDING THE EURO

German Chancellor Angela Merkel said no country in Europe would be left on its own, and reiterated that the euro was a strong currency that would be defended to the hilt.

We know that the euro is our collective destiny, and Europe is out collective future, Merkel said in a speech to Germany's lower house of parliament. Nobody in Europe will be abandoned. Europe will succeed together.

European Commission President Jose Manuel Barroso urged leaders to act fast to reach a consensus, but Luxembourg voiced frustration at Germany and France who, as the motors of the EU economy, often dominate decision-making.

I can only warn Germany and France against making a claim to power, which reflects a certain haughtiness and arrogance and disregards the European principle of solidarity, Luxembourg's foreign minister, Jean Asselborn, told the newspaper Die Welt.

He said Paris and Berlin had a tendency to blow up problems ahead of EU summits, only to resolve them at the meetings.

EU diplomats have worked to finalize as many outstanding issues as possible ahead of the summit so that discussions can focus on crisis resolution. Officials fear that a lack of concrete action will be exploited by financial markets when trading picks up again next year.

The European Central Bank holds a regular, non-policy meeting on Wednesday and Thursday, when it is expected to agree to ask euro zone member states for more capital, a move to lower its leverage as it helps tackle the debt crisis.

That issue may be discussed among EU leaders on Thursday, when they will be joined for dinner by ECB Governor Jean-Claude Trichet. The ECB has come under pressure to step up its bond-buying program to help the likes of Ireland, Greece and Portugal, who are struggling to fund themselves in the market.

ECB CAPITAL BASE

Germany said it would support giving the European Central Bank more capital, with an official saying a bigger base would show financial markets that the central bank had the firepower to buy new government bonds if needed.

After nearly a year of tackling relentless debt problems, EU leaders are hoping that the lull in financial markets over the past two weeks will stretch into 2011. But that may be wishful thinking, with pressure points already on the horizon.

Portugal held its last debt auction of the year on Wednesday, selling 500 million euros of three-month treasury bills, but at a punitively high yield of 3.4 percent. Last month it sold the same amount at 1.8 percent.

Belgium, which saw the outlook on its sovereign debt lowered by Standard & Poor's on Tuesday, with the threat of a downgrade within six months, is also a growing concern for policymakers. And Spain's regional banks have yet to resolve all their debts.

Top EU officials, including Luxembourg Prime Minister Jean-Claude Juncker and the Italian finance minister, have called for the euro zone to consider issuing collective treasury bonds, or e-bonds, which would effectively mean the 16 euro zone countries sharing credit risk and debt issuance.

Germany is opposed to the proposal, which would expose its credit risk to the influence of riskier peripheral euro zone countries such as Portugal and Greece. The issue may be raised at the EU summit, but no decisions are expected.

It's so important that we speak about further political integration over the next few months, said Merkel. But also that we don't make the mistake of seeing a collectivization of the risks -- which would happen with euro bonds -- as the solution, because it isn't the solution at all.

(Additional reporting by Rex Merrifield and Marcin Grajewski in Brussels and Brian Rohan and Annika Breidthardt in Berlin, writing by Luke Baker, editing by Kevin Liffey)