The dollar rose broadly while the euro hit a more than two-month low on Tuesday, pressed by concerns over a recession in eastern Europe and the knock-on effect on European banks.
However, the single currency pared some losses after data showed a surprise pick up in the German ZEW economic sentiment survey in February.
The greenback rose against the yen after Japan's finance minister said he would resign following criticism of his behaviour at a weekend Group of Seven meeting.
And ongoing concerns over the global economy, banks' balance sheets and corporate results kept investors wary, with European shares down on the day, boosting flows into the dollar, which is currently perceived as a safe-haven currency.
"The main reason for the euro weakness is the worries not only about the European economy but also especially in Eastern Europe where currencies are falling rapidly across the board," said Nordea rate strategist Niels Christensen.
"That's reason to worry about European companies that have some engagement in the region, such as banks which could face further losses."
Credit rating agency Moody's said the recession in emerging Europe was likely to be more severe than elsewhere and would put financial strength ratings of local banks and their Western parents under pressure, fuelling simmering investor jitters about the region..
Moody's said the combination of higher provisions for bad debt, the rise in bank borrowing costs and falling currencies would weigh on the profitability of the banks concerned and erode their capital base.
The euro dropped as low as $1.2602 on Tuesday, its lowest since early December on trading platform EBS.
By 1035 GMT, it was down 1.1 percent at $1.2633, according to Reuters data.
The euro was down 1.1 percent at 88.56 pence after data showing British consumer price inflation fell much less than expected in January.
Concerns over the euro zone economies were also reflected outside of the currency markets, with intra euro zone bond spreads widening and the cost of insuring against a sovereign default reaching new highs for many countries including Austria, Germany and Ireland.
The dollar rose to its highest since early December against a basket of currencies at 87.685 and was last 1.0 percent higher at 87.386.
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The European currency was also under pressure on growing expectations that the European Central Bank will ultimately have to play catch up on rate cuts made by the Federal Reserve and Bank of England.
Figures derived from Eonia rates show the market anticipating euro zone interest rates will fall below 1.0 percent later this year, with a cut to a record low of 1.5 percent in March.
ECB President Jean-Claude Trichet said on Monday the economic situation was extremely difficult but policymakers must avoid laying the ground for future disorder, while another ECB official described the outlook for 2009 as "dismal".
UBS strategists said the ECB's refusal to discuss alternative monetary easing tactics could further hurt the euro.
"All other central banks in the G10 have frontloaded cuts one way or another and are openly discussing aggressively adopting unconventional measures," said UBS strategist Geoffrey Kendrick in a note.
"We believe the ECB's refusing to consider other options will continue to cast the euro zone in a negative light and sentiment on the euro will suffer accordingly."
The yen briefly weakened to its lowest in more than a month, at 92.75 per dollar, after Japanese Finance Minister Shoichi Nakagawa said he would resign after being forced to deny he was drunk at a G7 news conference..
The dollar was last up 0.2 percent at 91.87 yen.
Analysts said currency markets were also looking to a Tuesday deadline for U.S. car giants General Motors Corp and Chrysler LLC to submit turnaround plans showing how they can be made viable after receiving $13.4 billion in emergency aid.
