The euro hit a four-month low on Friday, extending declines prompted by fears Greece may leave the euro zone and on contagion jitters after Moody's downgraded 16 Spanish banks.
Worries that a possible Greek exit from the euro zone would put pressure on other ailing European economies weighed on the currency, which last fetched $1.2674, down 0.2% on the day. It has shed 4.1% in May, zeroing in on its 2012 low of 1.2624.
A drop below that level would take the euro to its lowest since August 2010, but traders suggested the euro's fall may now slow somewhat, adding that there might be options-related plays that could lend it support on Friday.
"I get a sense that for now traders would want to square their positions heading into a news-packed weekend with G8 as the main event," said Sumino Kamei, senior currency analyst at the Bank of Tokyo-Mitsubishi UFJ.
"After a sharp decline this month we may enter a wait-and-see mode around $1.26, at least until Greek election in mid-June," she said.
Further dampening risk appetite, U.S. data showed manufacturing in the mid-Atlantic states unexpectedly contracted in May and new claims for U.S. jobless benefits last week stuck at levels suggesting sluggish growth in hiring.
INCREASINGLY WORRIED
Investors are increasingly worried Greece could leave the euro following a second election in June. A poll, however, showed Greece's conservatives have overtaken the anti-bailout leftist SYRIZA in popularity.
But with the political situation in Greece volatile and the outcome of the elections still far from certain, most analysts viewed them as an important risk event.
"The second round of the Greek election may well put the actual exit process in motion, and we would likely see EURUSD test 1.20 in that scenario," said Jens Nordvig, global head of currency and fixed income strategy at Nomura Securities.
Option traders also expressed scepticism about the euro, driving one-month euro/dollar implied volatility to a three-month high at 11.47%.
As market players bet on more euro weakness, three-month risk reversals showed a firm bias for bearish euro bets, last standing at -3.4%, near five-month highs, pulling away from -2.15% at the start of the month.
RECOUPING LOSSES
The dollar and the euro recouped some of the hefty losses sustained versus the safe-haven yen the day before. The euro inched up 0.1% to 100.71 yen, off its lowest since Feb. 7 at 100.56 yen.
The next support level for the cross was seen at 100 yen, where a large option trigger was reported by a Tokyo-based options trader.
"It seems like people are now trying to brace themselves for the break of that trigger level," the dealer said.
Worried by the yen's renewed strength, Japanese Finance Minister Jun Azumi said in a veiled reference to intervention he was monitoring currency moves with extra care.
After rapid overnight moves in the Japanese currency, one-month euro/yen volatility shot up to 13.1/14.1%, the highest level in 5 months.
Meanwhile, the greenback also regained some ground against the yen and added 0.2% to 79.42 yen, above a three-month low of 79.13 yen plumbed on Thursday.
There were stop losses below 79.00 yen and 78.80 yen, while offers were likely to cap the dollars advance around 79.50, traders said.
Weak Asian bourses and soft China housing data yanked the legs from under the Australian dollar, which fell to the lowest since late November at $0.9826.
Souring the mood further, Australia and New Zealand Banking Group said that current volatile conditions in global markets have seen wholesale funding market for Australian banks freeze again.
