The euro extended losses on Monday, pulling further away from two-month highs, after Moody's cut Ireland's credit rating, highlighting the fragility of Europe's fiscal health.
The euro quickly fell to the day's lows of $1.2868 after the rating agency cut Ireland's government bond ratings to Aa2, from Aa1, saying the country had suffered a significant loss of financial strength.
The move came as markets are anxiously awaiting the results of stress tests on European banks due out on Friday, and after the IMF and EU suspended a review of Hungary's funding program at the weekend, saying the government must take tough action to cut its budget deficit.
The downgrade added to the gloom in stock markets, which fell in Europe and Asia as a sharp drop in U.S. consumer sentiment fueled worries that its economic recovery may be stalling.
The FTSEurofirst 300 <.FTEU3> index of leading European shares fell 0.4 percent in early trade, while the MSCI index for Asian stocks outside Japan <.MIAPJ0000PUS> dropped 1.2 percent, its worse daily performance this month, as investors sold riskier assets.
The Japanese market was shut on Monday for a holiday.
The key issue driving the market at the moment is slower global growth, said George Clapham, head of equities at Arnhem Investment Management in Australia.
Investors who believed the world economy is on shaky ground got more ammunition for their arguments on Friday after U.S. data showed consumer prices fell for the third straight month in June while consumer sentiment dropped to a near one-year low, the latest in a spate of weak reports.
Major U.S. stock indexes slumped as much as 3.1 percent, with the selling spilling over into Asia on Monday. <.N>
Reflecting investor anxiety about sluggish economic growth, sub-indices for the MSCI Asia ex-Japan share index showed shares in banks and firms that sold non-essential consumer goods were the worst performers.
The financial <.MIAPJFN00PUS> and consumer discretionary <.MIAPJCD00PUS> sub-indices were down 1.3 percent each.
In Hong Kong, consumer goods exporter Li & Fung <0494.HK> fell 2.6 percent, while Europe-focused retailer Esprit Holdings <0330.HK> was down 2.4 percent.
But some investors said that while the U.S. economy is no doubt weak, worries that it may fall back into recession may be overdone.
It's slowing but it's very unlikely to get a double-dip recession, said Khiem Do, head of the Asia multi-asset group at Baring Asset Management, which oversees $50 billion.
He said he had a slight preference for Asian and European stocks because they seemed cheaper than bonds.
Worries another recession may be on the cards have fueled demand in recent weeks for bonds, which are deemed a safer bet. For example, two-year U.S. Treasury yields are near record lows.
But there was no missing the weak tone in other markets. Oil prices slipped below $76 a barrel on concerns that U.S. fuel demand may wane, while safe-haven gold eased to $1,192.10 an ounce after falling to its lowest in more than a week in the previous session.
EURO AWAITS BANK STRESS TESTS
In currency markets, traders said they were not surprised at the euro's pullback on Monday, saying it had been expected after its recent rally, which has been largely attributed to short covering and weakness in the U.S. dollar.
(For a Reuters Insider video clip looking at the euro's technical chart patterns, please click on http://link.reuters.com/haz28m)
By mid-afternoon in Asia, the euro pared some of its losses from the Ireland downgrade news and traded at $1.2891, down 0.19 percent from Friday's levels in New York.
For the year, the common currency has shed 10 percent on worries about euro zone sovereign debt levels. That compares with a 6.7 percent gain in the yen, and a 5.3 percent drop in sterling.
Monday's drop in the euro benefitted the U.S. dollar, despite the growing concerns about the U.S. economy. The U.S. dollar index against a basket of other major currencies was up 0.2 percent at 82.643.
Investors are awaiting semi-annual testimony by U.S. central bank chief Ben Bernanke on Wednesday for his view on whether the economic recovery is faltering.
(Editing by Kim Coghill)