The euro turned higher on Tuesday as solid demand at debt auctions eased concerns about euro zone debt problems after Monday's downgrade of Greece to junk status by Moody's ratings agency.
The euro erased brief losses seen in the wake of a weak German ZEW investor sentiment survey, which renewed concerns about the negative effects of the euro zone debt crisis on the wider economy.
But analysts said the euro's falls had been unconvincing, with solid demand at auctions in Ireland, Belgium and particularly Spain, helping to push it back up.
The ability of the Spanish government to raise funds on the open market is clearly a relief to both Spanish and EU policymakers, said Jane Foley, research director at Forex.com.
But the higher yield being demanded highlights the difficulty countries such as Spain still face, she added.
At 1108 GMT, the euro was up 0.4 percent at $1.2272, just off best levels of the day. It had risen to $1.2298 on Monday as risk sentiment improved, before running into option protection ahead of a $1.2300 barrier.
Technical analysts noted next resistance at $1.2330, in line with the November 2008 low.
There is enough to stop people from aggressively selling euro/dollar, said RBS currency strategist Paul Robson.
S&P (ratings agency) had already downgraded Greece to junk, so the Moody's news was less significant, and the ZEW survey was weak but other survey data has been relatively good.
He said there was scope for a squeeze in euro short positions up to around the $1.26 level.
The euro has stayed above $1.20, well off its recent four-year low around $1.1876, with traders saying central bank bids around $1.2170 had cushioned earlier losses.
Analysts said euro short positions were also very stretched, with traders taking profits on current positions without taking on new shorts.
Commodity Futures Trading Commission data showed speculators boosted their bets against the euro in the week ended June 8, with net short positions just below record levels.
Euro gains may be limited, however, with worries about Spanish banks persisting after Spanish Treasury Secretary Carlos Ocana acknowledged on Monday that some Spanish lenders faced a liquidity freeze in the interbank market.
The Greece downgrade highlighted that these problems are quite severe and it is difficult to see the liquidity problems in Spain improving and I think the euro will struggle going forward, said Johan Javeus, currency strategist at SEB in Stockholm.
Moody's slashed Greece's rating by four notches, citing macroeconomic and implementation risks in the country's draconian austerity program and renewing doubts about Greece's ability to repay its debt.
This put a stop to the euro's impressive run over the past few sessions when a rally in equity markets prompted investors to take profits on hefty short positions, leading the single currency to stall just shy of resistance at around $1.23.
The euro erased earlier losses against the yen to turn 0.1 percent higher at 111.98 yen. The U.S. dollar lost 0.2 percent to 91.30 yen.
(Additional reporting by Neal Armstrong; editing by Chris Pizzey)