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UPDATE 3-Violent Catalan referendum jolts Spain's financial markets

* Spanish government borrowing costs surge

* Banks lead share index lower

* Euro weakens against broadly-stronger dollar (Updates throughout, adds graphics)

LONDON, Oct 2 (Reuters) - Spain's government borrowing costs surged and its stock market fell on Monday as investors weighed political fallout from the violent police crackdown on an independence vote in 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 opens 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 impact 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 7 basis points to 1.69 percent, stretching the gap with benchmark German equivalents to its widest in nearly four months.

The cost of insuring exposure to Spanish debt via credit default swaps also rose to a near one-month high.

FINANCIAL CONCERNS

After affirming Spain's BBB+ credit rating on Friday, S&P Global said tensions between central government and Catalonian authorities could start to weigh on business confidence and investment.

Spain's benchmark IBEX equity index was down around 1.3 percent, led by falls among Spanish banks. Banco de Sabadell and Caixabank, both based in Catalonia, dropped 5.3 percent and 4.4 percent respectively.

The impact outside Spain was modest, with the euro losing 0.7 percent against a broadly-stronger dollar.

The sharp rise in Spanish government bond yields also pulled Italian peers to their highest in 2-1/2 months, up as much as 5 bps at 2.22 percent.

Coming just a week after German elections 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.

But others said there was little read across for the rest of the bloc.

"The equity market suggests that the Catalonian vote is being treated as a domestic event since the Catalan movement doesn't want to destroy the EU or end Spain's membership of the euro," said Kathleen Brooks, research director at City Index in London.

(Reporting by John Geddie and Dhara Ranasinghe, additional reporting by Kit Rees and Helen Reid; Editing by Janet Lawrence)