FIAT DEALERS GARAGES

The German purchasing manager index (PMI) figures came a day after ratings agency Moody's changed its outlook for Germany, the Netherlands and Luxembourg to negative, warning that Europe's top-rated countries may have to increase support for indebted states such as Spain and Italy.

Analysts said worries that more Spanish regions will follow Valencia and request financial aid from Madrid would keep Spanish bond yields high and encourage investors to sell the single currency.

Data showing China's manufacturing output grew at its fastest pace in nine months gave the euro only a brief lift, with the overall trend for the currency remaining strongly negative.

"The China data lifted sentiment at the margin but you have to keep in perspective how big was the (euro's) bounce. Generally speaking the trend is down," said George Saravelos, FX strategist at Deutsche Bank.

"The PMI numbers were weak as expected, and the risk is that the ECB (European Central Bank) will potentially ease more."

The euro dipped 0.1 percent to $1.2106, retreating from a session high of $1.2138 hit shortly after the Chinese figures. It touched a two-year low of $1.2067 on Monday when Spanish bond yields hit euro-era highs.

Traders said there was support at an options barrier at $1.2050 and below that at the psychological level of $1.2000. Below there the next target would be the 2010 low at $1.1876.

The German PMI showed manufacturing and services activity shrinking in July. It followed a French manufacturing PMI survey that was also well below forecasts, highlighting how even the euro zone's core economies are suffering.

Private sector activity in the euro zone as a whole also shrank for a sixth successive month, which data collector Markit said was consistent with a quarterly GDP fall of 0.6 percent.

Weak growth and the deteriorating situation in Spain kept alive the possibility of a further interest rate cut or cash injection from the ECB, which could give investors even less incentive to hold the euro.

Since the ECB's rate cut earlier this month it has fallen heavily against a range of currencies, including those which usually fall in times of heightened risk aversion.

It last traded at A$1.1776 against the Australian dollar, close to Monday's record low of A$1.1690, and at C$1.2342 versus the Canadian dollar, also near a record low of C$1.2277 hit on Monday.

The euro fell 0.3 percent against the safe-haven yen to 94.70 yen, holding above Monday's low of 94.23 yen, its lowest in nearly 12 years.

TROIKA VISITS GREECE

The near-term outlook for riskier currencies, including the euro, is likely to be driven by the outcome of a visit to Athens by inspectors from the troika of international lenders whose bailout loans are keeping Greece from going bust.

Greece's economic plans have stalled in recent months, raising concerns it will not be given more funds unless it makes deeper spending cuts and sticks to the terms of its bailout.

Investor appetite to take on risk could take a further knock from U.S. gross domestic product figures on Friday that are expected to show slowing growth in the world's largest economy.

Poor U.S. data may slow the euro's decline against the dollar even as it falls against other currencies.

"Europe is in focus, but we need to keep in mind that disappointing U.S. data would make more U.S. easing steps likely, which could weigh on the dollar," said a market participant in Tokyo.

The safe haven dollar eased slightly against a basket of major currencies after hitting a two-year high of on Monday. The dollar index was at 83.752, down from the high of 83.999.

(Additional reporting by Lisa Twaronite, editing by Nigel Stephenson)

Spain's increasingly desperate struggle to put its finances right has seen its borrowing costs soar to levels that are not sustainable indefinitely. Italy, commonly regarded as too big to bail out, has been dragged along in its wake.

The Spanish Treasury raised 3.04 billion euros ($3.7 billion) of 3-, and 6-month T-bills, meeting its target. The average yield on the 3-month bill was 2.434 percent, up from 2.362 in June. For the six-month paper, the yield jumped to 3.691 percent from 3.237 percent last month.

"The most important takeaway from this auction is that Spain was able get all its debt out the door," said Nicholas Spiro of Spiro Sovereign Strategies. "Still, in March, Spain was able to issue six-month debt at a yield of under 1 percent, now it is paying 3.7 percent."

Spain had cushioned itself by securing well over half its annual debt needs in the first six months of the year when market conditions were more benign but that advantage has now evaporated.

On Friday, the government said it expected the economy to remain in recession well into next year while the autonomous region of Valencia became the first to ask Madrid for aid to pay debt obligations it cannot meet. Others are expected to follow.

Madrid has already asked for up to 100 billion euros to recapitalize its banks which have been battered by a four year economic downturn and a burst property bubble.

The government has launched a fresh 65 billion euros package of tax rises and spending cuts designed to chip away at its debt mountain but which will probably drive the economy deeper into recession.

On the secondary market, Spanish five-year government bond yields rose above 10-year yields for the first time since June 2001. Having to pay more to borrow shorter-term rather than longer-term is usually a sign that markets think the risk of a default or debt restructuring has increased. <GVD/EUR>

"The spread between 5- and 10-years moved to negative today, which is a classic sign that the market thinks the current trends are unsustainable for Spain's fiscal dynamics," said Nick Stamenkovic, bond strategist at RIA Capital Markets.

The alarming spiral of Spain's debt costs has banished any hopes that a bailout of its banks, or a June EU summit which gave the euro zone's rescue funds a green light to intervene in the markets, has put the debt crisis into abeyance.

Spain and Italy have called on their partners or the European Central Bank to help ward off market pressure, although Italian premier Mario Monti said on Monday the ECB did not have to leap into action just yet.

Although it has cut interest rates, the ECB has shown marked reluctance to revive its bond-buying program, the only mechanism that could directly lower borrowing costs.

French Foreign Minister Laurent Fabius said on Tuesday that further aid for Spain could take the form of an increase in Europe's rescue fund or action by the ECB.

"I hope it will not be necessary to intervene again," he told France 2 television. "If we have to intervene, it could be an increase in the firewalls ... or interventions by the central bank."

SPREADING PAIN

The euro zone as a whole is now subsiding into recession.

Business surveys on Tuesday showed the currency area's private sector shrank for a sixth month in July with the downturn that began in the euro zone's smaller economies now becoming entrenched in Germany and France.

Moody's Investors Service lowered its outlook for Germany, the Netherlands and Luxembourg to negative from stable late on Monday, citing an increased chance that Greece could leave the euro zone, which could spark a wave of uncontrolled contagion.

It also warned Germany and the other 'AAA'-rated countries that they might have to increase support for Spain and Italy.

Spanish Economy Minister Luis de Guindos flies to Berlin later to meet his German counterpart, Wolfgang Schaeuble.

The premium investors demand to hold Spanish 10-year bonds jumped to its highest level since the birth of the monetary union, at 7.6 percent, while the cost of insuring Spanish debt from default has also hit record highs.

Ten-year yields of over 7 percent have triggered spiraling debt costs in other European economies which have eventually led to bailouts, though de Guindos reiterated on Monday Madrid would not need more aid.

For investors, Spain has become the tipping point but Greece - where the debt crisis first exploded - remains a powder keg.

Inspectors from the EU, ECB and International Monetary Fund return to Athens on Tuesday to decide whether to keep the nation hooked up to a 130-billion-euro lifeline or let it go bust.

The euro zone has said it will keep Greece afloat through August while the inspection takes place but analysts say Athens cannot hope to meet its bailout terms without more money or time.

The new Greek government is trying to highlight a deeper than expected recession for throwing it off course while its lenders say it is failing to push through privatizations, market liberalization and tax reforms. The government has failed so far to find nearly 12 billion euros of extra cuts stipulated by its agreement.

Prime Minister Antonis Samaras said on Tuesday that Greece's economy could contract by more than seven percent this year, having already shrunk over each of the last four years.

(Additional reporting by Manuel Ruiz, Dina Kyriakidou, Nicholas Vinocur, Marius Zaharia, Emelia Sithole-Matarise, Ana da Costa. Writing by Mike Peacock,; editing by Anna Willard/Janet McBride)