* Spanish government borrowing costs surge
* Banks lead share index lower
* IBEX closes down 1.5 pct
* Euro weakens against broadly stronger dollar
* EU urges Spain to talk to Catalans, condemns violence (Updates prices to close)
By John Geddie and Dhara Ranasinghe
LONDON, Oct 2 (Reuters) - The Spanish government’s borrowing costs surged and its stock market tumbled on Monday as investors weighed up the political fallout from the violent police crackdown on an independence vote in the wealthy region of Catalonia.
The euro also drifted lower against the dollar after local officials said 90 percent of voters favoured secession in Sunday’s referendum, which Madrid declared illegal.
That opened the door to a unilateral declaration of independence in a region that accounts for a fifth of Spain’s economy and whose tax revenues are crucial to the national budget.
While many analysts expect the crisis to be resolved with an offer of more autonomy, they said the uncertainty could have an impact on the country’s economic growth and taint the reputation of Prime Minister Mariano Rajoy, who heads a minority government.
“This is probably the worst outcome for Madrid - there was violence but they didn’t stop the vote either and public opinion in Catalonia is more polarised,” said Federico Santi, an analyst at Eurasia Group in London, referring to reports of nearly 900 injured in the clashes with police.
“It is clear that risks to government stability are increasing.”
Mainstream parties largely back Rajoy’s opposition to Catalan independence, but the premier faces criticism over his handling of the issue.
Spanish government bond yields rose as much as 10 basis points to 1.713 percent, expanding the gap with the benchmark German equivalents to its widest in nearly four months.
They pulled back slightly but remained 7 bps higher in late trade at 1.68 percent.
The cost of insuring exposure to Spanish debt via credit default swaps also rose to a near one-month high.
After affirming Spain’s BBB+ credit rating on Friday, S&P Global said tensions between central government and Catalan authorities could start to weigh on business confidence and investment.
Analysts said one way forward would be to offer Catalonia greater financial autonomy, something that could weigh on national finances.
“More fiscal autonomy for Catalonia is a baseline scenario,” said Nordea chief strategist Jan von Gerich. “This would be a slight negative for Spain because even if you assume Catalonia covers its share of the national debt, that still leaves the national government with a shortfall to cover.”
In a note, analysts at ABN AMRO said that everything else being equal, Spain’s government debt ratio would probably rise from around 99 percent of gross domestic product now to around 115 percent in case of an independent Catalonia.
Spain’s benchmark IBEX equity index closed down 1.5 percent, its biggest one-day fall in almost two months.
Banco de Sabadell and Caixabank, both based in Catalonia, fell around 4.5 percent each.
The impact outside Spain was modest, with the euro losing 0.5 percent against a broadly stronger dollar.
The sharp rise in Spanish government bond yields also pulled its Italian peers to their highest in 2 1/2 months at 2.26 percent.
Coming just a week after a German election, which saw the far-right AfD become the third-largest party in the bloc’s most influential country, analysts at Rabobank said investors appeared to be reassessing broader divisions within the euro area.
Reporting by John Geddie and Dhara Ranasinghe, additional reporting by Kit Rees and Helen Reid; Editing by Larry King