LONDON (Dow Jones)--The euro dropped sharply across the board Thursday after Moody's Investor Services Inc. downgraded Spain's debt rating, but the common currency managed to recovered some ground later in the European trading session. The euro fell by 0.5% to trade as low as $1.3804 against the dollar after Moody's said it had cut Spain's debt rating to Aa2 with a negative outlook from Aa1 previously, only days after it had cut Greece's rating. However, the currency later clawed back some of its losses as the market digested the news and the European Central Bank reiterated its stark anti-inflation rhetoric in its monthly report, warning that "strong vigilance is warranted" to contain inflation risks. "The Spanish downgrade was not as much of a shock as the Greek one because we knew that Moody's expectations had worsened and that they were behind Standard & Poor's. The reaction in the euro has been muted because of those factors," said Jane Foley, senior currency strategist at Rabobank in London. The downgrade throws the euro zone's debt issues back into the limelight on the eve of the European Union summit. "Ahead of this week, [the euro's rate against the dollar] was almost totally focused on interest rate differentials, but this week the crisis has slipped back into the market's view," Foley said. The euro had already weakened overnight after surprisingly poor Chinese trade data weighed on sentiment and traders' appetite to place risky bets. The other main focus of the session was sterling, which slipped against both the dollar and the euro after the Bank of England chose to keep interest rates and its bond-buying program unchanged. The focus now turns to the minutes on March 23 to see whether any other Monetary Policy Committee members joined the hawkish camp this month. Sterling had been climbing throughout most of the European session and was given a boost after official data showed stronger-than-expected industrial and manufacturing production for January. The Office for National Statistics said manufacturing output rose 1.0% on the month in January, its fastest rate of growth in 10 months, and was 6.8% higher on the year--the fastest annual rise since November 1994. The New Zealand dollar briefly rocketed against the U.S. dollar at around 0900 GMT after a trader entered an erroneous order into the EBS trading system. The so-called Kiwi surged to US$1.0057 before immediately settling back down at the US$0.7345 area. More broadly, though, the currency held steady in European hours after the Reserve Bank of New Zealand decided to cut its key policy rate by 50 basis points overnight. Looking into the session ahead, traders will be focusing first on U.S. initial jobless claims in the week to Mar. 5 and the U.S. trade balance for January. After a steep fall the previous week, the markets are hoping for the third consecutive sub-400,000 reading in initial claims. The rise in the oil price is expected to push the trade deficit modestly wider. Later on in the session, the U.S. will publish its monthly budget statement for February, which is expected to underscore the unsustainability of government finances in the world's largest economy. In the U.K., the National Institute for Economic and Social Research will release its growth estimate for the U.K. economy in the three months to February. At 1155 GMT, the euro was trading at $1.3829 against the dollar, compared with $1.3907 late Wednesday in New York, according to trading system EBS. The dollar was at Y82.93 against the yen, compared with Y82.98, while the euro was at Y114.69 compared with Y115.06. Meanwhile, the pound was trading at $1.6178 against the dollar, compared with $1.6159 late Wednesday in New York. The ICE Dollar Index, which tracks the greenback against a trade-weighted basket of currencies, was at 77.037 compared with 76.692 late Wednesday in New York.

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