Falling demand both at home and abroad caused Spain's manufacturing slump to deepen in May, with output shrinking at the fastest rate in three years and Europe's biggest jobless total climbing further, a survey showed.

Markit's Purchasing Managers' Index (PMI) of manufacturing companies stood at 42.0 in May, down from 43.5 in April - the lowest level since May 2009, when Europe began to emerge from the first stage of the financial crisis.

The measure has not exceeded the 50 line separating growth from contraction since April of last year.

The sharp decline in May comes just as Spain is racing to convince international markets it can handle its banking troubles without an external bailout, while also reining in a gaping deficit.

Overspending by Spain's autonomous regions pushed its deficit to 8.9 percent of gross domestic product for 2011, well above a 6 percent target.

Doubts over how Spain will fund a 19 billion euros ($23.55 billion) bailout for troubled savings bank Bankia have also rattled markets, pushing the country's borrowing costs to record highs this week.

Economy minister Luis de Guindos has already predicted Spain's economy will contract by 0.3 percent in the second quarter, after a similar contraction in the first three months of the year.

Markit's PMI survey showed up domestic strains, the group said, but that internal lack of demand was compounded by heightened euro zone worries in May, as worries over a Greek euro exit grew and Spain's banking turmoil spooked investors. "Things went from bad to worse in the Spanish manufacturing sector during May. Rates of decline in output and new orders are now faster than at any time in the past three years," said Andrew Harker, economist at Markit. "All of this provided a further squeeze on the labour market as the rate of job shedding remained marked." Spain's unemployment rate stands at nearly 24 percent. Markit's new orders index, showing a decline in the level of fresh business for 13 straight months, recorded the lowest reading for three years, due to a particularly sharp fall in domestic demand in May. ( C) Reuters