(Reuters) - The euro slipped against the dollar on Wednesday after a German Bund auction found muted but adequate demand, and looked vulnerable to selling by investors nervous about euro zone sovereigns' ability to attract funding.
Many analysts described the German 10-year auction as not particularly impressive, although it was an improvement on a similar debt sale in November which had raised fears the bloc's debt crisis was spreading its strongest economy.
Investor appetite to buy euro zone government debt will be further tested when France sells bonds on Thursday, and at Spanish and Italian auctions next week. Markets are particularly concerned about Italy's ability to cover around 100 billion euros of redemption and coupon payments falling due in the first four months of the year.
The euro slid 0.5 percent to $1.2981, close to a session low of $1.2976, triggering reported stops below $1.3010.
All in all the auction was a slight disappointment, therefore the reaction is a little bit of risk aversion. Now the market is looking ahead to the auction from France tomorrow, said Niels Christensen, FX strategist at Nordea.
Nordea expects the euro to fall to $1.20 by the end of 2012, and Christensen said it would remain vulnerable against the dollar, sterling and yen, although positioning meant euro selling was struggling to gain momentum.
Data last week showed currency speculators boosted bets against the euro to a record high in the week ending Dec. 27.
Some market players said euro weakness was partly due to investors booking profit on a short-covering rally on Tuesday when the single currency rose to a one-week high of $1.3077.
Euro zone economic data also tempered risk appetite on Wednesday. The latest set of purchasing managers' indexes (PMIs) suggested the region is firmly on course for a moderate recession, even though the composite PMI reading was slightly better than expected.
Against the yen, the single currency was down 0.4 percent at 99.62 yen, holding above the decade low of 98.71 hit in holiday-thinned trade on Monday.
FRANCE IN FOCUS
France, which is seen at greater risk of contagion from the euro zone debt crisis than Germany, will auction between 7 and 8 billion euros of longer-dated bonds on Thursday.
Analysts said lacklustre demand at the auction could increase concerns that France could lose its triple-A credit rating. The country and its euro zone peers were put on review for a possible downgrade by Standard & Poor's last month and other ratings agencies have also warned that its top-grade status may be at risk.
There will be more attention on the French auction, especially as there are still overhanging concerns of downgrades. The situation in France is more fragile than in Germany, said Michael Sneyd, currency strategist at BNP Paribas.
Traders are also looking ahead to the meeting of French President Nicolas Sarkozy and German Chancellor Angela Merkel on Jan. 9 to see how much progress Europe can make on their pledge for tighter fiscal integration.
There was little market reaction to euro zone flash inflation data that showed inflation dropped 2.8 percent in December, as expected, from 3.0 percent previously.
As the euro came under pressure the dollar index rose 0.4 percent to 79.962. The greenback gained slightly against the yen, edging up to 76.69 yen, not far from a record low of 75.311 marked late last year.
Commodity currencies slipped as risk appetite wavered and players took profits from the previous day's rally.
The Australian dollar fell 0.5 percent to US$1.0315, down from Tuesday's two-month high of $1.0387. The New Zealand dollar also dropped, down 0.4 percent at US$0.7868.