(Releads with Saudi allies cutting diplomatic relations)
* Bahrain and Sudan sever ties to Tehran
* Riyadh acts after embassy in Tehran attacked
* Oil prices rise more than two percent
* Stock markets across Gulf drop sharply
By Sam Wilkin
DUBAI, Jan 4 (Reuters) - Saudi Arabia's Sunni allies rallied behind the kingdom on Monday and several joined Riyadh in severing or downgrading diplomatic relations with Tehran, deepening a sectarian split across the Middle East.
Bahrain and Sudan cut all ties with Iran, and the United Arab Emirates (UAE), home to hundreds of thousands of Iranians, downgraded its relations. Saudi Arabia broke off relations on Sunday after a mob stormed its embassy in Tehran.
Shi'ite power Iran accused Saudi Arabia of using the attack on the embassy as an "excuse" to sever ties and further increase sectarian tensions, after Shi'ites across the world denounced Saudi Arabia's execution of Shi'ite cleric Nimr al-Nimr.
A man was shot dead in Saudi Arabia's Eastern Province late on Sunday, and two Sunni mosques in Iraq's Shi'ite-majority Hilla province were bombed in the fallout from the dispute between the Middle East's top Sunni and Shi'ite powers.
Oil prices rose more than two percent, overcoming economic weakness in Asia, as the two big petroleum exporters traded insults and tensions spilled into other crude producers such as Iraq.
Stock markets across the Gulf dropped sharply, led by Qatar which fell more than 2.5 percent, with geopolitical jitters outweighing any benefit from stronger oil.
Crude importer China declared itself "highly concerned" with the developments, in a rare foray into Middle East diplomacy. The United States and Germany called for restraint, while Russia offered to mediate an end to the dispute.
The row threatened to derail efforts to end Syria's five-year-old civil war, where Saudi Arabia and other Gulf Arab powers support rebel groups against Iran-backed President Bashar al-Assad.
In neighbouring Lebanon, newspapers said the spat had clouded the hopes of filling the vacant presidency that had been raised last month after Iran and Saudi Arabia both voiced support for a power-sharing deal.
"DIVINE REVENGE"
After a furious response in Shi'ite communities worldwide to the Sunni kingdom's execution of Shi'ite Muslim cleric Nimr al-Nimr, Saudi Foreign Minister Adel al-Jubeir said Iran was creating "terrorist cells" among the kingdom's Shi'ite minority.
Saudi Arabia executed Nimr and three other Shi'ites on terrorism charges on Saturday, alongside dozens of Sunni jihadists. Shi'ite Iran hailed him as a "martyr" and warned Saudi Arabia's ruling Al Saud family of "divine revenge".