NEW YORK (Reuters) - The euro slid against the dollar on Wednesday in thin trading, weighed down by soft German economic data and profit-taking after three days of gains, but losses may be temporary as investors are more optimistic about European Central Bank action to lower Spanish and Italian borrowing costs.
The euro's sell-off against sterling after the Bank of England gave no indication it would provide further stimulus also put broad pressure on the euro zone's common currency.
"It was a combination of the weak German data and a bit of profit-taking, but overall we still see a further squeeze higher in the euro," said Mary Nicola, currency strategist, at BNP Paribas in New York.
"Expectations are really building about a strong ECB response to help Spain and Italy," she added.
Wednesday's economic numbers took the steam out of the euro's recent rally. Industrial output in Germany fell slightly more than expected in June. Separately, German imports fell sharply in the three months to June, and exports also dropped.
Figures on Tuesday also showed Italy shrank further into recession in the second quarter, while German industry orders fell more than forecast in June.
In early New York trading, the euro was down 0.5 percent at $1.2339, turning lower after gains that took it to a one-month high of $1.2443 on Monday. It dropped past reported stop-loss orders at $1.2350, before recovering slightly.
The euro's intra-day bias has turned neutral for now, but with a still positive outlook on the daily charts as long as $1.2132 minor support holds, which is this month's low, analysts said. The rebound from the $1.2040 trough, a more than two-year low hit on July 24 is still expected to continue.
Sterling rose against the euro after BoE Governor Mervyn King appeared cautious about future interest rate cuts, surprising investors. The euro last traded down 0.6 percent versus the pound at 78.86 pence.
Earlier, the BoE slashed inflation and growth forecasts in its Quarterly Inflation Report as the euro zone crisis continued to take its toll.
Prior to Wednesday, the euro had rallied, in tandem with stock markets and riskier currencies, since ECB President Mario Draghi said last week he was determined to save the euro from disintegration and warned markets not to bet against the currency.
Market players have so far been unwilling to test the ECB's resolve, and some banks have forecast the euro will push higher over the coming weeks.
Sterling reversed earlier losses against the dollar to hit a session high of $1.5672. It was last up 0.2 percent at $1.5645. Traders had sold the pound in recent days on expectations that downbeat BoE forecasts would lead speculators to position for more monetary easing.
But the report suggested the BoE was in no hurry to provide more stimulus, leading to those bets being unwound and helping the British pound, traders said.
The yen rose as global stock markets came under pressure and investors sought safe-haven assets and currencies. The euro fell 0.7 percent to 96.71 yen while the dollar was down 0.3 percent at 78.36 yen.
The dollar has stayed in a range between 77.90 and 78.80 yen for the past two weeks. But analysts said expectations of more U.S. monetary easing may hurt the dollar.
Boston Federal Reserve Bank President Eric Rosengren, who is known to favor a more activist approach to stimulating growth, said on Tuesday the Federal Reserve should launch another bond-buying program of whatever size and duration was necessary to get the economy back on its feet.
Traders also said there was potential for fund repatriation by Japanese institutional investors, which may also weigh on the dollar against the yen in the near term.
August typically sees large bond redemptions in U.S. Treasuries as well as coupon payments, and traders say Japanese investors holding Treasuries could potentially sell the dollar against the yen to bring home some of the proceeds.
Additional reporting by Anirban Nag in London; Editing by Padraic Cassidy