Spain is set to see its borrowing costs leap when it sells short-term bonds after concerns over its deficit and banking sector pushed longer term risk premiums above 6 percent and drove the cost of insuring its debt to a record high.
The developments fuelled concerns Madrid might fail to meet deficit targets as the country acknowledged it has probably tipped into its second recession since 2009. That would raise the risk of it being pushed into seeking an international bailout.
The common currency shed 0.2 percent to $1.3110, having aggressively pulled away from a nadir at $1.2995. Apart from short-covering, traders cited euro buying by European firms and repatriation of funds by euro zone banks as factors helping the pull back.
"There's a lot uncertainty about Spanish yields, so of course if something goes off script at the auction today the euro may come under pressure again," said Bank of Tokyo-Mitsubishi UFJ analyst Teppei Ino.
"That said, the support around $1.30 is very strong and it held overnight, so I would expect the currency won't be able to break it just yet."
Traders said there were stop-loss sell orders below $1.2970 and were eyeing an strong support at $1.2954, at the 61.8 percent retracement of the euro's climb from its January low to a peak in February.
The influential ZEW German sentiment index due at 0900 GMT could also swing the market in the event-packed day. It is seen dropping, to 20.0, from 22.3 in March - its highest level since June 2010.
"Even if ZEW comes well above expectations, it's really hard to find a reason to happily buy the euro at these levels, especially ahead of another Spanish auction" said Koji Fukaya, chief currency strategist in Credit Suisse in Tokyo.
Spain holds auctions of two-year and 10-year bonds on Thursday. Any sign that 10-year yields are heading closer to 7 percent - a level regarded as unsustainable - could prompt further euro weakness.
Compounding Spain's fiscal woes, its banks borrowed a record 316.3 billion euros ($412 billion) from the ECB in March, almost double the previous month's total, as they remained virtually excluded from wholesale credit markets.
"Investors are beginning to question if Spain's fiscal austerity measures could be sustainable as its economy deteriorates, while sluggish growth would push housing prices lower and raise the risk of nonperforming loans ballooning," said Takao Hattori, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.
Adding to uncertainty, South Korean Vice Finance Minister Shin Je-yoon said the Group of 20 nations will struggle to reach a deal on boosting the International Monetary Fund's resources at a finance ministers' meeting this week.
Against the yen, the euro was 0.2 percent down at 105.43 yen , h aving hit the trough of 104.63 yen on Monday, a level not seen since mid-February.
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