The euro tumbled on Tuesday to a two-month low against the dollar after ratings agency Moody's warned that western European banks may suffer downgrades because of problems in Central and Eastern Europe.
The yen meanwhile slid against the dollar as Japan's Finance Minister Shoichi Nakagawa announced he would resign after coming under strong criticism for appearing to be drunk at a Group of Seven nations' weekend meeting in Rome.
In late morning London trade, the European single currency sank as low as 1.2603 dollars -- last seen on December 4.
It later pulled back to stand at 1.2655 dollars, down from 1.2801 in electronic trade late on Monday, when US financial markets were closed for a public holiday.
Against the Japanese currency, the dollar firmed to 91.82 yen from 91.73 yen on Monday.
"The euro fell sharply against the dollar in response to a Moody's statement which said that banks with significant exposures to central and eastern Europe may face downgrades," said Barclays Capital analyst David Woo.
"Banks from Austria, Italy, France, Belgium, Germany and Sweden account for 84 percent of western European bank loans in eastern Europe.
"This highlighted the ongoing issue of links between the Eurozone and the Central and Eastern Europe economic slowdown."
Moody's released a statement overnight which warned that western European banks involved in eastern Europe will face "continuous" downward pressure.
"Deteriorating financial strength of East European subsidiaries has a negative spillover effect on their West European parents," the agency said.
"A widespread deterioration in the economic health of core markets in Eastern Europe is exerting negative rating pressure on subsidiaries' and eventually may also lead to a weakening of the parent bank's ratings assuming East European activities represent a significant part of total banking activities of the parent."
It added: Moody's expects continuous downward pressure on East European bank ratings as a result of weakening financial metrics predominantly driven by deteriorating asset quality and vulnerable liquidity positions."
Moneycorp commerical director Piers Cracknell said the news made investors dump the euro.
"Moody's press release stopped short of placing any particular institution on credit watch. Even so, it made investors more nervous about the eurozone banking system and the euro took a hit," Cracknell said.
Elsewhere, German investor confidence staged another surprising gain in February, with the ZEW index jumping by 25.2 points to minus 5.8 points, the ZEW economic research institute said on Tuesday.
In January, the index had already surprised markets with a gain of 14.2 points.
Analysts polled by Dow Jones Newswires had forecast a much more modest rise to minus 25 points for the biggest European economy.
Also on Tuesday, the pound dropped against the dollar as worries persisted about the health of the British economy and its banking sector.
In London trading on Tuesday, the euro changed hands at 1.2665 dollars against 1.2801 dollars late on Monday, at 116.06 yen (117.46), 0.8868 pounds (0.8955) and 1.4786 Swiss francs (1.4844).
The dollar stood at 91.82 yen (91.73) and 1.1699 Swiss francs (1.1596).
The pound was at 1.4253 dollars (1.4298).
On the London Bullion Market, the price of gold rose to 960.84 dollars an ounce from 942.50 dollars late on Monday.
