Renewed speculation about a French downgrade reminded investors that the three-year-old euro zone debt crisis is not solely confined to the region's peripheral economies, but has affected Europe's core nations as well. However, a senior French source told Reuters on Wednesday that France has not been informed of any forthcoming downgrade to its credit rating, and that eased selling of the euro a bit.
Adding to the euro's bearish tone were comments from Fitch ratings agency's head of sovereign ratings that the ECB should ramp up its buying of troubled euro-zone debt to support Italy and prevent a "cataclysmic" collapse of the shared currency.
"The euro is on the backfoot once again because of the French downgrade rumors and then we got the Fitch warning," said Dean Popplewell, chief currency strategist at OANDA in Toronto. "So it's the same old story. Any negative news or headline on the euro zone is sending investors to the sidelines."
Investors are focused on a slew of euro-zone events that could dictate where the currency is headed. Spain on Thursday will sell up to 5 billion euros of 2015 and 2016 paper, just hours before the ECB's first monetary policy announcement and interest-rate decision for 2012. Italy offers up to 4.75 billion euros of five-year bonds on Friday.
The euro temporarily jumped to around $1.2730 after German Chancellor Angela Merkel said Germany would be prepared to supply more capital to the European Stability Mechanism fund when it is launched later this year.
The bounce did not last. The euro slumped to a 16-month low of $1.2661, according to Reuters data. In late afternoon New York trading, the euro was at $1.2704, down 0.5 percent on the day.
"The Fitch news rattled the market, and Merkel's comments offset that temporarily, but overall, the main focus remains on this week's ECB meeting and debt auctions," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.
"There is a lot of event risk, and that has investors wary of holding euros, keeping it biased lower," he said. "The market is so short euros that it could bounce on short-covering if the sales fare well, but that will likely not last because it does not alter the euro's broader negative outlook."
In addition, concerns about recession in Germany also undermined risk sentiment. A preliminary estimate from the Federal Statistics Office in Wiesbaden showed the German economy contracted around 0.25 percent in the fourth quarter.
Germany sold 3.153 billion euros in five-year notes on Wednesday with yield of 0.9 percent, a euro-era low. Demand was solid at 2.8 times the amount on offer. However, the generally strong auction provided little lift to market sentiment.
'WORST' AHEAD, ECONOMISTS SAY
ECB policymakers are expected to keep rates on hold at 1 percent and strike a downbeat tone as they press governments to step up their efforts to tackle the debt crisis.
"Having just lowered interest rates in December to 1 percent, the central bank is not expected to ease again, particularly since last month's rate cut came with a new program that makes it easier for cash-strapped banks borrow," said Kathy Lien, director of FX research at GFT in Jersey City.
"The ECB will want to give the economy time to absorb the latest round of easing before pumping more money into the economy."
The central bank, however, is under pressure to support Italy, so cautionary comments will hurt the euro, Lien added.
According to a Reuters poll of economists, the worst is yet to come in the euro zone's debt crisis, but the currency union will survive 2012 intact. They also said France will probably lose its top-notch credit rating.
While just nine of the poll's 64 economists said the bloc had turned the corner on the sovereign debt crisis, only 10 said the euro zone would not survive the year in its current form. The rest were reasonably confident it would.
The euro struggled versus the Australian dollar, setting a record low of A$1.2347. Against the yen, the common currency fell 0.6 percent to 97.628, not far from an 11-year low of 97.28 yen set on Monday on EBS.
The dollar edgted up against the yen to 76.890 yen, staying above a two-month low of 76.30 yen hit last week.