A sharp rise in Spain's borrowing costs on Thursday sent the single currency lower as fears rose that a full sovereign bailout was inevitable, but European shares hit 11-weeks highs as second-quarter company results lifted sentiment.
Despite all the efforts by Madrid to cut its budget deficit and tackle problems in its banking system, government bond yields rose sharply at an auction of two- to seven-year debt.
"We're still waiting for the bank bailout to be finalised, and there's no guarantee that Spain itself won't need a bailout at some stage," said Marc Ostwald, a strategist at Monument Securities in London.
In the immediate aftermath of the auction, 10-year Spanish government bond yields extended their recent rises, adding a further 7.3 basis points on the day to 7.03 percent. Five-year yields were up 10 bps at 6.44 percent.
A 10-year bond yield of over 7 percent, as happened with Greek, Portuguese and Irish sovereign debt, is a level many analysts consider to be unsustainable.
The main Spanish share index, the IBEX, turned negative after the sale and was down 0.2 percent.
Spain should receive some good news later in the day when the German parliament votes on the rescue programme for its troubled banks, which should then pave the way for a formal approval by euro area finance ministers on Friday.
In contrast to Spain, French borrowing costs plunged at an 8.96 billion euro sale of bonds maturing in 2015, 2016 and 2017, with two-year yields running at near zero.
France is benefiting from demand by investors for the debt of the euro zone's best-rated sovereign issuers after the European Central Bank cut its overnight deposit rate to zero earlier this month.
In the wake of the ECB's move, French bonds have rallied strongly, with the premium investors require to hold 10-year French bonds over their German equivalent falling 25 basis points so far this month.
The euro fell to a day's low of $1.2263 after the Spanish auction result, having already fallen against the yen and hit record lows against the Australian and New Zealand dollars.
The U.S. dollar also weakened, mainly because the Federal Reserve Chairman Ben Bernanke had kept alive talk of more monetary easing in the second stage of his testimony to the U.S. Congress on Wednesday, though he had played down the risks of a double-dip recession.
"Pressure remains on the dollar, as the Fed chief's remarks keep alive the possibility of more U.S. easing to come," said Masashi Murata, senior currency strategist at Brown Brothers Harriman in Tokyo.
The dollar fell to a two-week low against a basket of currencies, with the dollar index hitting 82.70, and the greenback traded at a six-week low against the yen.
In equity markets investors remained focused on the second quarter earnings season and the outlook for corporate profits.
The FTSEurofirst 300 index of top European shares was up 0.3 percent at 1,056.99 points and on track for a seventh straight week of gains.
"There have been some good company results, which have lifted sentiment. But I don't think investors have been complacent as the euro zone situation is still in the background," said Keith Bowman, equity analyst at Hargreaves Lansdown.
Most of the good news on corporate profits has emerged from the United States, where, of the 63 companies in the S&P 500 index to report second quarter earnings so far, 71.4 percent have beaten analysts' expectations, 11.1 percent have been in line with forecasts and only 17.5 percent have fallen below estimates.
The positive numbers, which have included many big name tech companies such as Intel Corp and Honeywell, sent the S&P 500 to its highest level since early May on Wednesday, helped also by some good news on house building.
The gains spilled over into Asia helping send the MSCI world equity index up 0.5 percent to 314.07 points.
MIDEAST TENSION RISES
In oil markets the deadly bombing in Syria and an attack on Israeli tourists in Bulgaria have helped lift Brent crude oil to a seven-week high above $106 a barrel by bringing supply concerns back into focus.
The gains were capped by data from the Energy Information Administration (EIA) on Wednesday showing crude stocks in the United States fell less than expected last week as crude imports rose and refineries scaled back processing rates.
Gold took its cue from the weaker dollar, though investors were less than convinced of its direction, given the uncertainty over Fed stimulus measures and persistent worries about Europe.
Spot gold gained around 0.5 percent to trade around $1,580 an ounce.