Asian shares hit a month-high on Wednesday, buoyed by optimism about the world's top two economies, but the euro struggled on concerns over euro zone sovereign funding ahead of key auctions.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> inched up 0.1 percent, retreating on profit taking after earlier hitting its highest since December 9.
Australian shares rose and the pan-Asian materials sector <.MIAPJMT00PUS> outperformed for a second day in a row on the back of Tuesday's rally in copper, oil and gold.
Japan's Nikkei average <.N225> took comfort from a rise in U.S. stocks to five-month highs on Tuesday on hopes for better U.S. corporate earnings, but worries about the euro zone capped the increase at 0.2 percent.
It's got a little bit overdone over the past couple of days, particularly in Shanghai Composite, but the pullback today is really pretty small, so I think it is technical in terms of the market getting a little bit overbought, said Guy Stear, head of research with Societe Generale in Hong Kong.
Shanghai shares <.SSEC> have risen about 7 percent since Friday's low, while Hong Kong's Hang Seng Index <.HSI> has climbed about 4 percent this week.
Asia's lower price-to-book and less net foreign buying suggests less risk of a January correction, Credit Suisse said in a research note, referring to 2010 and 2011 when the pan-Asia index peaked in the first week of January after some early exuberance.
But overall market sentiment remains cautious about the prospects of Europe extricating itself from its deep-rooted debt problems any time soon, raising concerns that the crisis would eventually overshadow the modest improvement seen recently in U.S. data.
Later on Wednesday, German Chancellor Angela Merkel and Italian Prime Minister Mario Monti meet to discuss the euro zone crisis, while German annual gross domestic product data will be released, with 3 percent growth forecast in 2011.
But the primary focus this week is Spanish and Italian debt auctions on Thursday and Friday, as the two big euro zone economies are seen as most at risk from the crisis.
U.S. crude futures eased below $102 a barrel on the European worry, but supply jitters from Iran's nuclear programme dispute with the West and unrest in Nigeria lent some support.
The euro fell 0.3 percent to $1.2734, slipping from the previous day's high of $1.2819 hit after credit rating agency Fitch said it did not expect to cut France's triple-A rating this year.
Fitch may not cut France this year, but there is risk that other rating agencies may downgrade France, so the situation in the euro zone overall has not changed, said Junya Tanase, chief currency strategist at JPMorgan Chase in Tokyo. A risk-on sentiment can easily turn around any time.
Tanase said commodity-linked currencies -- such as the Australian dollar -- may be more resilient to risk-off sentiment than the euro as commodities prices were underpinned by supply and other factors.
Asian credit markets were less optimistic on risk than equities, with spreads on the iTraxx Asia ex-Japan investment grade index barely narrowing from Tuesday's levels.
(Editing by Alex Richardson)