The euro weakened about 1% percent against the dollar and the yen on Wednesday, the day before an important auction of long-dated Italian debt, while US stocks slid more than 1% on concerns about the economy in early 2012.
The European single currency hit a fresh 11-month low against the dollar of $1.291 and a 10-year low against the yen as data showed banks were hoarding the cash recently injected by the European Central Bank rather than lending it out – a bad omen for the European economy in 2012.
"If European banks are still this concerned, it's not a good sign," said Karl Schamotta, senior markets strategist with Western Union Business Solutions. "That underlines the possibility that this liquidity crunch is getting worse and will continue into the new year.
Earlier Italy brought festive cheer to the markets on Wednesday with a debt auction that saw its short-term borrowing costs fall by half.
The sale of bills and bonds was the first big test of market sentiment since the European Central Bank provided eurozone lenders with a €489bn (£408bn) liquidity injection on 21 December. Italian banks reportedly took up more than €100bn of the ECB's three-year loans.
The results of the auction suggested the offering had made a big impact on the readiness of lenders to buy sovereign debt. The rate on €9bn of six-month treasury bills plunged to 3.25% from 6.50% the last time that securities of a similar maturity were auctioned on 25 November. Demand outstripped supply in a ratio of 1.7 to one, compared with 1.5 last month.
Improved sentiment with respect to Europe and Italy in particular may have played a role. The financial daily, Il Sole-24 Ore, reported on its website that the strong demand from banks was an important element of support for the Rome treasury, but added that "what counts for more is the return of final institutional investors, of the big foreign funds".
The FTSE MIB index of Italian blue chips shot up by more 1.7% as the auction results reached the Milan bourse. But stocks then lost ground and, by an hour and a half before the close, the index was 0.35% down on Tuesday's close.
The Italian treasury faces a much bigger test on Thursday, when it aims to sell €8.5bn of bonds with maturities ranging from three to 10 years. And there are signs that, because of uncertainty over the eurozone, investors want steeply higher returns for buying longer-dated debt.
Wednesday's auction also involved €1.7bn of zero-coupon notes maturing in 2013. They sold for 4.85%, down from 7.81% in late November. The bid-to-cover ratio was nevertheless a healthy 2.2. That compared with 1.6 last month.
The latest figures provided a boost for the government of Mario Monti, brought in to turn around Italy's public accounts. Commentators had been asking increasingly pointedly why it had so far failed to bring down borrowing costs.
