The euro slipped off seven-week highs against the dollar on Wednesday on concerns about the global economic recovery and as investors scrutinized details of plans to test the financial health of European banks.
A European committee of bank supervisors will outline on Wednesday the methodology for stress tests of about 100 banks but German banking sources said the test would exclude a haircut on German sovereign bonds.
The euro eased 0.3 percent to $1.2581 at 1048 GMT, after reaching $1.2663 on trading platform EBS on Tuesday, its highest level in about seven weeks.
It was little changed after worse-than-expected data showed factory orders in Germany, the euro zone's largest economy, fell for the first time this year in May.
There's still an awful lot of uncertainty in Europe and the stress tests are the next big event... If growth concerns return then Europe will be worse hit than the U.S., said Derek Halpenny, European head of global currency research at BTM-UFJ.
We're not predicting a double-dip recession but uncertainty over growth will persist in the next six months and if that happens defensive currencies like the dollar will still do well.
Traders said the euro may be hemmed in as options with strike prices at $1.2500 and $1.2600 expire later in the day.
Analysts said the euro had gained support after a solid Spanish syndicated debt sale on Tuesday eased euro zone debt fears and weak U.S. data hit the dollar.
The euro ended U.S. trading above the resistance line at the bottom of the daily Ichimoku cloud, a technical signal that its downtrend may be over. The single currency slid beneath the Ichimoku cloud, a Japanese chart closely followed across markets, in mid-December and has mostly traded below it since.
Analysts said the single currency could rise further in the short term as a raft of weak U.S. data prompts investors to unwind long dollar positions and short euro positions built up since the start of the year, but market players were still refraining from taking long positions in the euro.
Yesterday was a short-term correction to a long-term downtrend. Euro/dollar could still go up but I would be surprised if it went much higher, said Michael Hewson, currency strategist at CMC Markets. Markets are looking at the credibility of stress tests today. German factory data is down. These things undermine the euro.
The dollar fell 0.3 percent to 87.28 yen, not far from a seven-month low of 86.96 yen hit on EBS last week.
Against other currencies, the greenback pared losses made on Tuesday after a lackluster report on the U.S. service sector added to other recent data suggesting recovery in the world's largest economy was slowing and shares gave up Tuesday's gains as demand for riskier assets faded.
The dollar index .DXY edged up 0.13 percent to 84.195, staying near a two-month low of 83.825 hit this week.
The Australian dollar, which has a strong correlation with Asian shares, fell 0.6 percent to $0.8474.
Traders said the world's other major central banks may also need to ease policies further in the event of a U.S. double-dip and that the implications for currencies were far from clear.
Kit Juckes, currency strategist at Societe Generale, said the euro would fall when short-term euro zone interest rates came down or the remorseless grind lower in U.S. yields ended.
I don't like the euro or the dollar either, he said. I'm nervous of this apparently cozy consensus that we won't have a double dip.
(Additional reporting by Tamawa Desai in London; Editing by Nigel Stephenson)