The euro lost some ground on Tuesday, a day after short-covering helped it pull away from two-month lows against the dollar, and remained vulnerable ahead of a Spanish bond auction as euro zone debt jitters showed no signs of abating. 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.
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. 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.
"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. Against the yen, the euro was 0.2 percent down at 105.43 yen, having hit the trough of 104.63 yen on Monday, a level not seen since mid-February. The Australian dollar fetched $1.0320, down 0.4 percent on the day, with support seen around 1.0310, while the New Zealand dollar was down 0.5 percent at $0.8157.