Nervous investors kept the euro and stocks within narrow ranges on Thursday with interest focused on any signal from the European Central Bank's rate meeting about a policy easing and a Spanish bond sale that will test demand for Europe's debt.
The single currency edged up 0.1 percent to $1.2714, after earlier bouncing off support at $1.2700. It had fallen as low as $1.26615 in New York on Wednesday.
There's a possibility the ECB will prepare the market for more rate cuts, and that should be negative for the euro, said Marcus Hettinger, global currency strategist at Credit Suisse in Zurich.
Sterling fell to a three-month low versus the dollar of about $1.5288, dragged lower as investors took profits on short positions in the single currency.
We see testing times ahead for the market, with uncertainty reverting higher, European currencies remaining under pressure, and safe haven assets such as the U.S. dollar getting fresh support, said analysts at Barclays capital in a research note.
Investors were bracing for the year's first real test of demand for debt from the euro zone's bruised periphery, with Spain set to offer around 5 billion euros (4.1 billion pounds) of 2015 and 2016 paper. Italy will auction up to 4.75 billion euros of five-year bonds on Friday.
Markets are also closely watching the outcome of the European Central Bank policy meeting, a day after the head of sovereign ratings for Fitch warned the ECB should ramp up its buying of troubled euro zone debt to support Italy and prevent a cataclysmic collapse of the euro.
After two back-to-back interest rate cuts and last month's provision of nearly half a trillion euros in three-year loans, the ECB is seen keeping rates unchanged at a record low 1.0 percent.
Equity investors were also in a defensive mood with the MSCI world equity index <.MIWD00000PUS> down around 0.05 percent after a subdued session in Asia.
European stocks were mixed at the open with the FTSEurofirst index <.FTEU3> index of top European shares little changed in choppy trading, a day after it touched 1,029.32 , the highest since early August.
GREEK DEBT WOES HAUNT
Renewed worries over Greece's debt troubles are also weighing on sentiment. Talks about private sector creditors paying for part of a second Greek bailout are going badly, senior European bankers told Reuters, raising the prospect that euro zone governments will have to increase their contribution to the aid package.
U.S. Treasury Secretary Timothy Geithner said during his visit to Tokyo on Thursday that Europe was making progress in resolving its two-year-old sovereign debt crisis, but creating a firewall around the euro zone to prevent the crisis from spreading was a crucial next step.
On the economic front November factory output data for the UK and the euro zone may provide some insight into the strength of the slowdown in the troubled region.
Data out earlier showed China's annual inflation had eased to 4.1 percent in December, the lowest level in 15 months, raising the possibility of a shift in policy priorities away from containing price increases and towards supporting growth.
Safe-haven gold inched up around $1,645.60 an ounce, close to its one-month high of $1,646.90 hit, amid the concerns about the euro zone's debt crisis.
Oil prices were firm at just over $113 a barrel rose as worries about possible supply disruptions from Nigeria and Iran offset pressures from high inventory build and euro zone woes.
(Additional reoprting by Naomi Tajitsu; Editing by Anna Willard)