The euro hit an 11-month low against the dollar in Asia overnight amid further concern over Europe's attempts to stem the debt crisis.
The currency, which fell below $1.31 yesterday for the first time since January, was trading at $1.3030 in Asia earlier.
Piling more pressure on the embattled currency, German leader Angela Merkel has rejected any suggestion of raising the funding limit of Europe's future bailout fund, the European Stability Mechanism, sources said.
A spike in Italian bond yields above 7 per cent for the first time in nearly two weeks also soured the mood.
"There is some buying on the dip and option-related bids stabilising the euro today, but the bearish trend is by no means over. By the beginning of 2012 it's likely to drop to around $1.25," said Koji Fukaya, chief FX strategist at Credit Suisse.
German deputy finance minister Steffen Kampeter told CNBC that market reaction to the euro-area agreement on new fiscal rules was "completely irrational" and investors are attributing too much risk to the region.
"I think the markets will realize it if they have taken some time off over the holiday - and when they start in January with a calmer mood, they will see how big the achievement is," Mr Kampeter said
The common currency has held up remarkably well despite extreme volatility in the euro zone bond market, but the break of a stalwart support point around $1.32 has raised the risk of a quick move to the 2011 trough hit on January 10th at $1.2860.
A trader for a Tokyo bank said leveraged funds are partly to blame for the decline, having been dumping the euro since late last week. He said their selling was concentrated around the start of London trading and the funds appeared to be enlarging a short position and selling most aggressively when the euro came under pressure.
The ESM, which will replace the current EFSF bailout fund and should come into effect from the middle of next year, will have an effective lending capacity of €500 billion.
European Council chief Herman Van Rompuy said yesterday a review of whether funding was adequate would be completed in March.
"The credibility of the European response is very much in doubt, driving EUR/USD lower," said Kit Juckes, head of foreign exchange research at Societe Generale.
"European institutions continue to hammer the point of what they are not willing to do. The market is driving down the point of how little they are willing to risk in a deleveraged financial system, and this ahead of the holidays."
The market's focus is turning to an Italian bond sale later today, and another by Spain tomorrow. The danger of a credit ratings downgrade may keep borrowing costs punishingly high for both, traders said.
"The euro traded with scant reference to euro zone bond developments on Tuesday, but that does not mean a good, bad or ugly auction today will not be a source of significant FX volatility on Wednesday," BNP Paribas analysts said.
Markets were braced for a possible mass downgrade of euro zone countries, which would deepen the region's debt crisis, after last week's key summit offered no hopes for an immediate resolution. A downgrade for France could come any day.
The US Fed also highlighted the turmoil in Europe as a big risk to the US economy, keeping intact an easing bias.
Agencies
