The dollar strengthened broadly on Tuesday after a media report questioning the health of the German banking system prompted traders to trim back bets against the dollar that had driven it to a five-month low last week. Britain's Daily Telegraph reported that Germany's financial regulator BaFin had warned that toxic debt of the country's banks would blow up "like a grenade" unless they took advantage of government bad-bank plans to prepare for the next phase of crisis. The report was not new, however, as the regulator warned last week that German banks have bad assets of around 200 billion euros ($280 billion). Still, traders used it as an excuse to sell the euro and cash in on the currency's rise of 8 percent in just a month against the dollar from $1.30 to $1.40. A greater test of market sentiment comes later in the week with the U.S. Treasury's note auctions totaling $101 billion. The government will sell two-year notes on Tuesday, five-year notes on Wednesday and a seven-year paper on Thursday. "The news out of Germany that BaFin is quite concerned about the writedowns which probably still have to be done in the German banking sector (shows) it's premature to expect that the situation in the euro zone is anything like stable enough to justify the increase in euro/dollar," said Michael Klawitter, senior currency strategist at Dresdner Kleinwort in Frankfurt. At 0800 GMT (4:00 a.m. EDT) the dollar index .DXY, a gauge of the greenback's performance against six other major currencies, was up 0.4 percent on the day at 80.34. On Friday it fell to a 2009 low of 79.805, a day after an outlook downgrade to Britain's AAA sovereign debt rating prompted speculation that U.S. government debt may lose its top-notch rating. The euro fell 0.5 percent to $1.3940. On Friday it rose as high as $1.4051 on trading platform EBS, its highest since early January. The euro lost more ground against the yen, trading down 0.8 percent on the day at 131.85 yen, while the dollar lost 0.2 percent against the Japanese currency to trade at 94.66 yen. US AUCTION A reported missile launch by North Korea on Tuesday weighed on equity and commodity markets, offering some support for the yen and dollar, traders said. Trading activity picked up following U.S. and UK holidays on Monday. Continental European markets were open on Monday, however, and Ifo think tank's German business climate index fell short of market expectations, suggesting that any recovery in the euro zone's biggest economy will take time. Figures on Tuesday confirmed that Germany's economy shrank in the first quarter at its fastest ever pace since reunification in 1990, thanks to record falls in exports and investment. The market's attention will quickly turn to the United States, however, and the Treasury's debt auctions, particularly the level of interest shown by foreign central banks. "The main risk .... is whether sovereign bidders finally lose appetite and shift their focus," said UBS in a note on Tuesday. "As such, a low indirect bidder participation rate during this week's auctions may also damage the dollar, but we also note that it is not in the interests of the world's major reserve holders to act disruptively at this stage."

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