* S&P cuts sovereign to 1 notch above junk, outlook negative
* Warns aid request delay a potential negative for rating
* Inflation hits 16-month high in September
* Spain banks' dependence on ECB continues
* Econ Sec says Spain still considering aid request
(Updates bond yields) By Paul Day and Rodrigo De Miguel
MADRID, Oct 11 (Reuters) - Spain faced renewed pressure totake the politically humiliating step of seeking sovereign aidon Thursday after a credit agency cut its rating for thegovernment's debt to near junk.
Standard and Poor's said recession was limiting Spain'soptions on policy and said Madrid's delay in asking for aidcould drag on the new rating, which it kept on negative outlook- indicating another cut is in prospect.
Another headache for the government came with data showingconsumer prices rose at their fastest pace in 16 months inSeptember, further depressing demand among cash-strappedconsumers.
"We expect the current situation to continue to run untileither market or political pressures become more acute," U.S.investment bank JP Morgan said in a note to clients. "Thepromise of ECB action may be holding back both sorts of pressurein the near-term, and there is little evidence to suggest thateither will necessarily reappear over the next few weeks."
The European Central Bank's plan to buy the bonds ofstruggling governments has raised hopes of an end to the mostacute phase of the euro zone's crisis. Spain's delay in askingformally for such aid is steadily undermining such hopes.
Prime Minister Mariano Rajoy, who has said he will only makean aid request decision when he had all the details, is thoughtto be waiting for regional elections Oct. 21 and, if the ECBeffect keeps debt costs down, he may delay a decision further.
While neither Rajoy or the euro zone's paymaster Germanyseem keen for Spain to dive in to a rescue plan, further marketpressure or a sovereign downgrade to junk would hasten theprocess, economists say.
"In the short term we suspect that the noise and columninches generated by the S&P downgrade will be disproportionateto its impact," Citi said in a note.
"But the longer term impact could be very significant if themarket sees the trajectory towards Spain's eventual exclusionfrom (investment grade) indices as inevitable."
Secretary of State for the Economy Fernando Jimenez Latorrereiterated that Madrid was still considering whether to applyfor aid.
S&P's action brought it in line with peer Moody's, whichalso has Spain on the verge of losing its investment grade andis due to complete a review of that rating this month.
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For a graphic on euro zone sovereign ratings: Spain yield curve: Debt and bond yields Economy overview ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> RISING YIELDS
Spanish borrowing costs have fallen well back from levelsabove 7 percent that triggered bailouts for other euro zonestates, but the yield on its 10-year bond rose to nearly 6percent early on Thursday before dipping back to 5.82 percent,down on the day.
The yield remains around 180 basis points below the levelsit reached before the ECB first suggested it would start abond-buying programme.
Improved funding conditions over the last month have helpedSpanish corporates and banks, including Santander andBBVA , return to markets for funds and reduce relianceon the ECB for funding.
"There has been a window for Spanish companies and banks totap the bond markets and that has reduced the reliance inSeptember, but it is still too early to talk about a new trendand overall the dependence on the ECB seems high," said NuriaAlvarez, analyst at Madrid-based Renta 4.
The Treasury plans a private placement of 4.86 billion euros($6.3 billion) of bonds maturing in 2015, 2016 and 2017 onThursday to finance part of a fund aimed at reducing financingcosts for Spanish regions that have been shut out of markets.
Its efforts to cut back public spending and retrench thebudget include a 3-point rise in VAT to 21 percent last month.Data on Thursday, however, showed that drove inflation to 3.4percent - another burden for households already struggling withunemployment of 25 percent and cuts in pay and benefits.
The resulting grim growth outlook is undermining Rajoy'splans to cut the deficit from 8.9 percent of national output to4.5 percent next year. Economists worry that higher inflationwill also lead to higher rises in inflation-indexed pensionsthat could further undermine the push.
"Indexation of pensions might challenge fiscal targets, butit is not the only risk. We are also concerned about lowergrowth and decline in employment," S&P's economists told Reutersin an email on Thursday.
IMF chief Christine Lagarde suggested on Thursday thatEuropean governments should take more time with cutbacks toreduce deficits, but Deputy Prime Minister Soraya Saenz deSantamaria said Madrid would stick to its existing timetable.
($1 = 0.7751 euros)
(Additional reporting by Jesus Aguado and Manuel MarÃa Ruiz;Editing by Tracy Rucinski/Jeremy Gaunt.)
Keywords: SPAIN ECONOMY/PRICES