LONDON, June 23 (Reuters) - The euro held steady on Wednesday but remained vulnerable as a recent risk rally appeared to have run its course and on concerns about the euro zone banking system.
A sharp fall in U.S. stocks .SPX the previous day and a subsequent drop in the Nikkei .N225 helped support the dollar and the yen, which are favoured when risk aversion spikes and doubts over the health of the global economy emerge.
European shares were last down 0.7 percent .FTEU3.
With advanced economies tightening their fiscal policies, the risks of economic slowdown are rising, said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ.
By 0728 GMT, the euro was up 0.1 percent from late U.S. trading on Tuesday at $1.2279 EUR=, having dipped to as low as $1.2244 earlier.
The euro is now hovering close to a support area near $1.2255. That level marks a 38.2 percent Fibonacci retracement of the euro's recent rally from its four-year low of $1.1876 hit in early June on trading platform EBS to a one-month high of $1.2490 marked on Monday.
A clear break below that level could open the way for a drop towards $1.2145 to $1.2165, an area where the euro hit a number of intraday lows in mid- to late-May, traders said.
Worries about the euro zone's banking sector returned after French bank Credit Agricole (CAGR.PA) pushed back profit targets for its struggling Greek unit Emporiki (CBGr.AT) and said it will take a 400 million euro ($536.7 million) write-down as Greece fights its debt load.
That followed a ratings downgrade of French bank BNP Paribas by Fitch and S&P's announcement on Monday that it had raised estimates for loan losses for Spain's banking sector.
The dollar index, which measures the dollar's value against a basket of currencies, was down 0.1 percent at 86.01 .DXY, but up from a one-month low of 85.091 marked on Monday.
Against the yen, the dollar fell 0.1 percent at 90.39 yen JPY=.
Sterling gained 0.4 percent against the dollar to trade at $1.4868 GBP=D4 in the wake of the new UK government's budget released Tuesday, which investors concluded was tough enough to address Britain's fiscal problems and keep rating agencies from downgrading its sovereign debt.
The pound has enjoyed a relief rally post-budget, analysts at RBC Capital Markets said in a note.
Minutes of the Bank of England's June 9-10 policy meeting are due out later in the day.
Meanwhile, the Swiss franc extended gains, hovering near an all-time high against the euro of 1.3585 francs on trading platform EBS earlier in the Asian session.
Market euphoria after China's decision to loosen the yuan's 23-month-old peg to the U.S. dollar at the weekend faded as traders concluded China would keep adjustments limited.
China's central bank set the yuan's daily mid-point CNY=SAEC at 6.8102 against the dollar on Wednesday, compared with 6.7980 on Tuesday, which was its highest since the yuan's revaluation in July 2005.
China is introducing more two-way volatility into the yuan, said BTM-UFJ's Hardman.
The Australian dollar fell 0.4 percent at $0.8688, backing away from a one-month high of $0.8860 hit earlier in the week.
Market players will also keep an eye out on central bank policy meetings. The Norges Bank's decision due out at 1200 GMT is expected to show interest rates unchanged but a lower rate trajectory going forward.
The U.S. Federal Reserve is expected to keep rates on hold and restate its intention to keep rates near zero for an extended period. [ID:nN17269337] (Additional reporting by Masayuki Kitano in Tokyo; Editing by Toby Chopra)