The euro dropped against the dollar on Monday as record high Italian bond yields and political uncertainty fanned fears about the euro zone debt crisis.

While Greece's attempts to get its bailout plan back on track remained a concern, investors were on edge over Italy's fate, the bloc's third biggest economy.

The yields on Italy's 10-year bonds hit their highest in 14 years at 6.67 percent, with many analysts and market players seeing 7 percent as a major threshold above which funding costs would be unsustainable for the country.

We don't think the Europeans have contained the crisis at all, said Christopher Sebald, chief investment officer at Advantus Capital Management in St. Paul, Minnesota. It likely takes more market stress before that happens.

Sebald, who oversees $22.8 billion in assets under management, said the European Financial Stability Facility does not have enough capital nor is it big enough, with leverage, to comfortably fund Italy's debt maturities.

Greece has potentially provided a road map for other countries to negotiate lower debt repayment, he said. Therefore worries about orderly and disorderly defaults will likely stay with us, along with the prospects for euro zone and U.S. recession, for several months.

Italy faces a crucial vote on public finance in parliament on Tuesday and the center-left opposition said it was preparing a motion of no-confidence in the government that would bring Prime Minister Silvio Berlusconi down even if he should survive Tuesday's vote.

In late morning New York trade the euro was down 0.4 percent at $1.3734. Against the yen, the euro was down 0.5 percent at 107.28.

Sebald said Advantis has been buying U.S. mortgage-backed security pass-throughs.

We will also likely be moving into more corporate bonds over the next couple of months as spreads are attractive currently, even though the risk level will remain high from U.S. and Europe, he said.

Berlusconi tried to hang on to power on Monday and denied reports that he would suddenly resign. Reports of a possible resignation had temporarily boosted the euro.

A new government, or another leader could probably have more support from the parliament and bring more reforms, said Marcus Hettinger, global FX strategist at Credit Suisse.

(But) from the currency side I don't see why that would have a long-lasting positive effect. Growth is basically what is needed everywhere to reduce deficits.

SWISS FRANC SINKS

The safe-haven Swiss franc tumbled against the euro and the dollar after the Swiss National Bank chairman suggested the franc was still overvalued against the single currency, reviving speculation the SNB may raise the 1.20 franc floor on the euro/Swiss exchange rate.

Analysts said the franc's recent gains were driven mainly by euro zone developments, and Swiss policymakers would take that into account before deciding whether to raise the floor. But with data showing deflation in October, the SNB had room to take more measures to weaken the franc.

The euro was last up 1.5 percent at 1.2384 francs. The dollar was up 2 percent at 0.9012 francs.

Against the yen, the dollar was a down 0.2 percent at 78.04 yen.