The euro plunged to a two-year low against the dollar on Tuesday and further declines were likely as euro zone ministers failed to calm fears about the debt crisis and investors awaited a German court verdict on the region's bailout fund.
The euro zone common currency fell beneath $1.2250, opening the way to a test of $1.20. A break below that could see the currency slide toward its June 2010 low of $1.1875, which marked the weakest level since March 2006.
"It's almost like we're drilling for oil - we're going down slowly in the euro," said Matthew Lifson, senior trader and market analyst at Cambridge Mercantile Group in Princeton, New Jersey. "There's no backbone to the euro at the moment. The market is just plodding it lower."
Euro zone ministers agreed to grant Madrid an extra year, until 2014, to reach its deficit reduction targets in exchange for further budget savings. They did not agree on a final figure for aid to ailing Spanish lenders, but said some 30 billion euros would be available by the end of July.
Markets were disappointed the meeting did not offer more.
Investors were also on edge as the German Constitutional Court began a hearing into whether the euro zone's bailout fund, known as the European Stability Mechanism, and planned changes to the region's budget rules are compatible with German law.
The euro has been net sold for five consecutive trading sessions and is now the strongest net sold currency across the board, said Samarjit Shankar, managing director of global FX strategy at BNY Mellon in Boston.
The euro fell as low as $1.2233, its lowest since July 1, 2010. It last traded at $1.2253, down 0.5 percent.
In the options market, one-month implied volatility inched lower to 9.95 percent on Tuesday after jumping to a two-week high of 10.65 percent on Monday.
Meanwhile, the cost of insuring against a euro fall cheapened somewhat on Tuesday, with one-month puts trading at 1.0 percent, compared with 1.5 percent at the beginning of the month. The bias remains skewed toward euro weakness. The euro also fell to a five-week low against the yen, at 97.20 yen, and last traded down 0.7 percent at 97.31, according to Reuters data.
Italian Prime Minister Mario Monti, under intense market pressure to shore up his country's economy to prevent it from being drawn into the center of the debt crisis, said Italy could be interested in tapping the euro zone's rescue fund for bond support.
One bit of good news for the euro came by way of a drop in Spanish and Italian borrowing costs, with Spain's 10-year bond dipping back below the critical 7 percent level.
Analysts said the political hurdles on how to use the euro zone's rescue fund and prevent further contagion remained very high.
Sterling, meanwhile, hit a 3-1/2-year high against the euro , which fell to 78.92 pence, as the market's focus switched back to the euro zone debt crisis. That spurred the pound to recover from an early dip caused by comments from the Bank of England governor. The euro was last at 78.94 pence, down 0.5 percent.
China also weighed on markets after trade figures raised concerns about a downturn in the world's second-largest economy. The dollar last traded down 0.2 percent against the yen at 79.40 yen.