By William L. Watts, MarketWatch LONDON (MarketWatch) -- Rising tensions between North Korea and South Korea, renewed fears over the fate of Europe's banking sector and a sharp selloff by global equities ensured safe-haven flows boosted the U.S. dollar Tuesday, strategists said, while the European single currency tumbled back toward its recent low. The dollar index (DXY 87.11, +0.90, +1.04%) , which tracks the U.S. unit against a basket of six major currencies, erased an earlier loss to rise to 87.336, up from 86.229 in late North American trading on Monday. The euro (CUR_EURUSD 1.2239, -0.0103, -0.8346%) traded at $1.2196, down from $1.2399 late Monday, opening up the prospect of a test of the four-year low near $1.2144 set on May 19. The euro also dropped against the Japanese yen (CUR_EURYEN 113.1400, +2.1300, +1.9187%) to ¥108.91, from ¥112.19 late Monday. European equities followed Asia to sharp losses Tuesday, with weakness exacerbated by bank-related concerns after the International Monetary Fund warned Monday that Spain must do more to accelerate the consolidation of its banking sector and to overhaul its labor laws and government pension system. The warning fell after the Bank of Spain took over CajaSur, one of the nation's regional lenders, or cajas, which fell due to its exposure to Spain's collapsed property bubble. While the IMF said the banking sector remained sound, the comments added to negative sentiment on the euro, which exhausted a short-lived short-covering bounce that last week took the currency from its low near $1.2144 to a high near $1.2670. "The long-term fundamentals are not in favor of the euro. Even more, it becomes ever more obvious that several 'South' European countries desperately need a weaker currency to restore competitiveness," wrote strategists at KBC Bank in Brussels. "On top of that, a lot of the credibility issues that have been raised recently on European fiscal and monetary policy are not yet solved." Risk appetite was also hurt by news reports Tuesday that the North Korean government ordered its citizens and troops last week to be ready for combat. On Monday, South Korean President Lee Myung-bak suspended trade ties with the North, after investigators concluded that a torpedo fired by a North Korean submarine sank one of Seoul's naval ships on March 26, resulting in the loss of 46 South Korean lives. Read more on Korean tensions. The developments helped sink Asian equities, lifting the dollar and, in particular, the Japanese yen, which has tended to outperform all of its rivals during periods of rising risk aversion. Against the Japanese yen, the dollar (CUR_USDYEN 89.5200, -0.7000, -0.7759%) slipped to ¥89.34 from ¥90.53 late Monday. The South Korean currency weakened sharply against the U.S. dollar, with the greenback buying 1,249.70 Korean won, up 3% from 1,212.15 won on Monday afternoon. Read more on South Korean won. The higher-yielding Australian currency was also under renewed pressure The Australian dollar (CUR_AUDUSD 0.8133, -0.0108, -1.3105%) bought 80.88 U.S. cents, down 0.8%, and 72.27 Japanese yen, down 1.2%. The British pound (CUR_GBPUSD 1.4343, -0.0053, -0.3681%) slipped to $1.4314 from $1.4443 late Monday. The pound largely took its cue from the euro. British gross domestic product for the first quarter was revised up to show a 0.3% quarterly gain, slightly stronger than the initial estimate of a 0.2% expansion. Read about U.K. GDP.

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