The euro hit a fresh 11-month low against the dollar on Wednesday, one day before an important auction of long-dated Italian debt, while U.S. stocks fell about 1 percent on concerns about the economy in early 2012.

Italy's strong sale of short-term bonds Wednesday morning initially brought some relief to European markets, but concerns about Thursday's more challenging auction eventually hurt market sentiment.

U.S. stock indexes fell more than 1 percent in thin trading as investors feared what many expect to be a tough start to the year. The broad S&P 500 index erased its 2011 gains after just turning positive in last week's rally.

There are clearly some major hurdles on the horizon, said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey. Looking into next year, there is more apprehension about the risks associated with the current climate.

The Dow Jones industrial average fell 127.75 points, or 1.04 percent, to 12,163.60, while the Standard & Poor's 500 Index lost 14.07 points, or 1.11 percent, to 1,251.36. The Nasdaq Composite Index was down 29.75 points, or 1.13 percent, at 2,595.45.

Wall Street's decline weighed on European stocks, which erased early gains. The FTSEurofirst 300 index of top European shares fell 0.71 percent to end at 983.32, after rising as much as 0.63 percent earlier in the session.

The MSCI All-Country World index lost 1.27 percent, taking losses for the year to more than 10 percent.

The decline in stocks lifted prices of U.S. government bonds. Benchmark 10-year Treasuries rose 24/32 in price, with the yield at 1.9179 percent - below the psychologically significant 2 percent level.

U.S. crude oil prices fell $1.92 to $99.42 a barrel. They had gained more than one dollar in the previous session following Iran's threat to stop oil shipments through the Strait of Hormuz if Western countries impose new sanctions on its exports.

Tehran faces the prospect of further sanctions from the European Union by the end of January over its nuclear ambitions. Washington said it saw an element of bluster in the threat to close the Gulf.

The threat by Iran to close the Strait of Hormuz supported the oil market yesterday, but the effect is fading today as it will probably be empty threats as they cannot stop the flow for a longer period due to the amount of U.S. hardware in the area, said Thorbjoern bak Jensen, oil analyst with Global Risk Management.

ITALIAN AUCTIONS

The euro slid to a session low of $1.2938, its lowest since January, as investors worried about Italy's sale of 8.5 billion euros worth of debt with maturities of up to 10 years on Thursday. It last traded 0.9 percent weaker at $1.2944.

Earlier, the single currency briefly rose against the dollar after Italy's short-term debt costs halved at an auction, helped by a new government austerity package and cheap liquidity from the European Central Bank.

Italy will need greater commitment from international investors to sell its bonds on Thursday, however.

Tomorrow's auction is more important and will give more insight into general sentiment. Today was a warm-up, said Neil Mellor, currency strategist at Bank of New York Mellon.

Another factor contributing to the euro's weakening was a report by the European Central Bank that showed regional banks were still taking on liquidity to build reserves instead of adding risk.

There appeared to be reluctance among European banks to lend to each other or invest in euro-zone sovereign debt, analysts said, despite the ECB's recent massive liquidity injection through a three-year refinancing operation.

If European banks are still this concerned, it's not a good sign, said Karl Schamotta, senior markets strategist with Western Union Business Solutions. That, in turn, means we're looking at a potential impact on growth in the new year.

(Additional reporting by Edward Krudy and Luciana Lopez; Editing by Kenneth Barry,; Jan Paschal and Dan Grebler)