The euro hit a ten-year trough against the yen and its lowest since the start of 2011 against the dollar ahead of a bond sale on Thursday that will measure Italy's chances of making it through a daunting first quarter for public finances.
European shares inched higher in trade thinned by the holiday season while oil prices steadied above $107 a barrel, still showing the impact of Iran's threat to block flows through the Straits of Hormuz, a vital trade route.
German bond prices inched up and the gap between Italian and German benchmark debt yields widened slightly, reflecting a cautious tone ahead of Italy's sale of up to 8.5 billion euros (7.1 billion pounds) of three- and 10-year paper.
There were optimistic signs for Rome in a halving of its cost of borrowing over six months on Wednesday, but Thursday's auction provides a sterner test of investors' faith in its ability to service a huge public debt burden.
The Treasury has to refinance more than 150 billion in bills and bonds in the first few months of 2012 and its longer term yields remain close to levels at which other struggling euro zone governments were forced to seek bailouts.
The auction yesterday was good but today's will be more of a barometer for what appetite will be at the start of next year, said Carl Hammer, currency strategist at SEB in Stockholm.
Italy has a massive refinancing need early next year and markets are a bit worried about it.
By 0910 GMT the euro was down 0.1 percent at $1.2922, just off levels of $1.2887 hit in Asian trade - the lowest since January 10. Against the yen, it reached a 10-year low of 100.33 yen on the EBS trading platform, driven by selling from Japanese retail investors and exporters.
London's FTSE stock market inched up 0.1 percent, while markets in Frankfurt and Paris both rose around 0.3 percent.
Asian markets fell earlier following a more than 1 percent drop on Wall Street overnight and the Nikkei ended 0.3 percent lower. The MSCI ex-Japan Asia Pacific index also shed 0.3 percent and both indexes look set to be down about 18 percent during 2011.
The Italian auction is also the first test of banks' willingness to buy longer-term sovereign debt with the nearly 500 billion euros in three-year funds that they borrowed last week from the European Central Bank.
If it goes well, it's an indication that, one, yield is coming down, so the cost of funding is falling for the Italian government, said Martin Lakos, division director at Macquarie Private Wealth.
And, two, if there's demand for the paper, that's a sign of confidence, which is what the market's in real need of.
The ECB's injection of cash, together with the lull in markets at the end of the year, have eased some of the immediate pressure on Italy and Spain in a debt crisis dating back more than two years.
But despite being awash with liquidity, banks still appear distrustful; they deposited a record 452 billion euros with the ECB's overnight facility on Tuesday rather than lend to each other, while emergency overnight borrowing also remained high at above 6 billion euros.
Worries over banks and government debt look set to continue to weigh on the euro in 2012, especially given signs of improvement in the U.S. economy that may support the dollar.
Nobody sees anything on the horizon that could be mildly positive for the euro, said Rob Ryan, FX strategist for BNP Paribas in Singapore.
Brent crude oil rose 25 cents to $107.81 a barrel after falling nearly $2 the day before, with a stronger dollar and rising U.S. crude stocks offsetting the concerns over Iran.
A big increase in U.S. crude oil stocks and the falling euro against the dollar are the main pressure points for the market at the moment, said Ken Hasegawa, a derivatives manager with brokerage Newedge in Tokyo.
We also had six consecutive days gaining in the oil market, so it is not strange to see some profit-taking.
(Additional reporting by Jessica Mortimer and Kirsten Donovan in London, Masayuki Kitano and Randy Fabi in Singapore; Editing by John Stonestreet)