Safe-haven assets were back in demand on Tuesday as investors limited their risks ahead of a German ruling on the euro zone's new bailout fund, an election in the Netherlands and potential new stimulus from the U.S. Federal Reserve.
European shares, which jumped to 13-month highs last week after the European Central Bank laid out new plans to address the region's debt crisis, were stuck in negative territory for the second day running, 0.44 percent lower at 1,098.66 points.
The MSCI global share index was down a more modest 0.1 percent ahead of what was expected to a slightly higher open on Wall Street where investors are eyeing a potential new dose of stimulus from the Federal Reserve.
Europe is having another testing week as it seeks to pull itself out of its debt woes.
Despite a late legal challenge from a eurosceptic lawmaker, Germany's constitutional court will rule on Wednesday on the powers of the euro zone's new ESM bailout fund, which is vital to release funds to recapitalise struggling Spanish banks.
"The decision is the sole thing that could blow the whole thing out of the water," said Gary Jenkins, managing director at Swordfish Securities.
"It's unlikely they'll do that, but if there's one obstacle that it would be hard to see a way around, that would be it."
Dutch voters also go to the polls that day in the latest test of core Europe's resolve to keep the bloc intact, while European authorities will lay out their blueprint for a new 'banking union' to synchronise bank supervision and bailouts.
The German court statement that it would not delay its ESM ruling sparked life into a subdued euro, sending it back above $1.2800 and towards its $1.2834 200-day moving average before retreating back slightly.
The dollar weakened elsewhere, too, hitting a three-month low against the Swiss franc, a six-week low against the yen and was fractionally down against a wider basket of currencies.
PERIPHERY SELL OFF
With the European action on Wednesday, Apple
"It is one of those 'wait-and-see days' where we have a week full of catalysts that basically start tomorrow, so with that, this market probably sees a day full of sideways action," said Art Hogan, managing director of Lazard Capital Markets in New York.
The European sell-off of riskier assets left German government bonds, typically favoured by risk-shy investors, back in demand.
Bund futures were up 13 basis points at 140.44 as uncertainty remained around the outcome of the ESM ruling and as worries resurfaced on Greece's fiscal repair plans. In contrast Italian, Spanish and Portuguese borrowing costs were all on the rise.
Oil prices remained firm, with Brent crude futures back above $115 a barrel. Safe-haven favourite gold, which has rallied nearly 7 percent over the last month, added 0.4 percent to $1,731 an ounce.
Reflecting growing investor jitters, the CBOE Volatility index posted its biggest daily increase in seven weeks on Monday.
Speaking in China, International Monetary Fund deputy managing director Zhu Min warned that despite the recent positive step by the ECB the euro zone debt crisis still had a long way to run.
"Overall I would say the crisis is not over. We are still in the middle of it and there is some way to go," Zhu told a World Economic Forum meeting in the port city of Tianjin.
ECB in graphics http://link.reuters.com/neg32s
Euro debt crisis graphics http://r.reuters.com/hyb65p
Italy,Spain market overview http://link.reuters.com/xyq57s
Spanish,Italian bond spreads http://link.reuters.com/vur47s
STIMULUS HOPES
Monetary stimulus continues to prop up large parts of the global economy. Interest rates cuts are expected in the coming months from Europe to key parts of Asia and Latin America
One of the factors currently weighing on the greenback is Thursday's conclusion of the Federal Reserve's September policy meeting, with economists increasingly eyeing another injection of stimulus following weak jobs data last week.
The dollar dropped during the two previous rounds of quantitative easing from the Fed, with the U.S. dollar index falling around 17 percent between March and December 2009, and by around 13 percent between August 2010 and May 2011.
Lee Hardman, currency analyst at Bank of Tokyo Mitsubishi, said the Fed's actions were likely to have less of an influence this time, especially as other central banks were also acting to support their economies.
"In these circumstances, a more extended U.S. dollar sell-off on the back of QE3 will likely require more aggressive quantitative easing from the Fed than prior bouts ... which appears unlikely," he said.
So far the U.S. dollar index has already fallen by close to 5 percent, he added.
