LONDON (Reuters) - The euro hit a near two-year low against the dollar on Thursday after dire German economic data suggested no country in the region was immune from crisis, alarming investors already fretting over the risk that Greece will leave the euro zone.
A weaker-than-expected Ifo business climate index and manufacturing PMI data for May suggested growth in Europe's largest economy that has helped the currency bloc dodge recession may be starting to slow.
Signs of a downturn across the region, banking sector problems in Spain and the risk of contagion ensnaring bigger economies are all combining to keep euro bears firmly in control, with some investors targeting $1.20 in coming weeks.
The euro dropped sharply to $1.25155 on trading platform EBS, its lowest level since July 2010, before recovering to trade at $1.2575 as some investors booked profits on bearish positions initiated earlier. But any rebound was likely to be fleeting and draw more sellers.
Traders reported an options barrier at $1.2500 with more stop-loss orders cited at $1.2480.
The euro has lost 1.4 percent against the dollar so far this week with sentiment already fragile after a European Union leaders summit on Wednesday failed to shed new light on how they might tackle the euro zone debt crisis.
"After the (EU) summit without any results we have still got a lot of uncertainty in Greece. The last thing we need in this situation is the German economy getting into trouble," said Lutz Karpowitz, currency strategist at Commerzbank.
"There are a lot of short positions so there is always a possibility of a retracement in the euro but that does not change the overall (weaker) trend."
Real money investors and macro funds have stepped up selling of the euro in recent days as concerns Greece might quit the euro zone intensify. Fears of a Greek exit have mounted after an inconclusive election this month left the country on the path to bankruptcy and raised the risk of contagion.
Three officials told Reuters on Wednesday that members of the currency bloc have been told to prepare contingency plans in case Greece quits the euro, an eventuality that the German central bank said would be testing, but "manageable".
Greeks will vote again on June 17, with polls showing a neck-to-neck race between parties which support and those which oppose the terms of the country's international bailout keeping markets on edge.
"All roads lead to a lower euro and our forecast is euro should be at $1.15 by the end of the third quarter," said Tom Levinson, currency strategist at ING.
"It still makes sense to go short at these levels, given the high level of uncertainty about Greece. While short positions are quite high and there is a possibility of a squeeze which could see the euro higher, any rebound is a sell on rallies."
European Central Bank data showed 35.4 billion euros of net direct portfolio investment flowed out of the euro zone in March, suggesting investors are starting to shun the region's assets.
The poor German economic data led more investors to the safety of the dollar and the yen. The euro was down 0.15 percent against the yen at 99.852, having fallen to 99.37 yen, its lowest level since February 1.
The dollar index .DXY climbed to a 20-month high of 82.362, while the greenback rose to a 15-month peak versus the Swiss franc of 0.95959 francs on trading platform EBS.
Against the yen, the greenback was steady at 79.38 yen, showing limited reaction after Bank of Japan governor Masaaki Shirakawa said the central bank was resolved to maintain its ultra-loose monetary policy but would not ease solely to weaken the yen.
Earlier in the session, data showing that China's factories faltered in May had limited impact on major currencies, as market players had been expecting a weak reading.
Additional reporting by Anirban Nag; Editing by Catherine Evans