The dollar was in demand Wednesday as investors worried about the next instalment of the euro-zone debt crisis fled currencies and markets deemed as relatively risky and sought refuge in the greenback and German bunds.

The pound was a notable faller after the Bank of England raised the prospects of renewed quantitative easing by cutting its U.K. economic growth forecast.

The euro plunged to four-month lows against the dollar at the start of European trading to trade at $1.2681 and sank to a three-and-a-half year low against sterling, trading as low as GBP0.7950. The Australian dollar was also under pressure, slipping to its weakest level against the dollar since December, to trade as low as $0.9870.

Elsewhere, yields on Italian and Spanish government bonds surged and the cost of insuring against a Spanish default hit a record high, while European stock markets sank.

The selloff then levelled off before the results of a German 10-year government debt auction as traders reversed their bets, although investor sentiment remained jittery as rumors swirled the market.

"We are entering a very dangerous phase," said Derek Halpenny, a currency strategist at the Bank of Tokyo Mitsubishi-UFJ in London. "Greece is still in the euro zone and...we are seeing contagion starting to spread already."

At the auction, Germany sold EUR4.107 billion of a 1.75% July 2022 bund at an average yield of 1.47%, the lowest on record for 10-year German debt.

"Demand was decent...and flight-to-quality flows have also been supportive," said brokerage firm Newedge in a note.

Meanwhile, consumer prices in the 17 countries that share the euro fell in April compared with a year earlier, in line with expectations, and showed a 0.5% rise from March and a 2.6% rise on the year.

The BOE's inflation report reversed sterling's recent strong run as the central bank suggested that inflation will take longer to return to target than previously thought and cut the country's growth forecast to 2.6% from 3%. Traders sold the pound against the euro fearing extra stimulus measures from the BOE.

The pound plunged to $1.5888 from $1.5987 before the report while the euro bounced off the three-and-a-half year low hit in earlier trade, towards the GBP0.80 mark.

Emerging-market currencies swooned, with the Indian rupee sliding to record lows. The authorities in Indonesia and South Korea were suspected of intervening to support their currencies, while traders were reportedly nervous of similar action in Thailand, Malaysia and India.

The greenback traded at a four-month high against the Russian ruble at RUB31.14 and against the Turkish lira at TRY1.8334, while it hit a five-month high against the South African rand at ZAR8.3922.

The minutes of the Federal Open Market Committee are still to come at 1800 GMT, and developments from Greece will be closely watched.

At 1042 GMT, the euro was trading at $1.2713 from $1.2730 late Tuesday in New York, according to trading system EBS. The single currency was at EUR0.7983 compared to EUR0.7959 and it was trading at Y102.24 from Y102.09.

The dollar was trading at Y80.39 compared to Y80.18 late Tuesday and at CHF0.9445 from CHF0.9435. The pound was trading at $1.5924 from $1.5996.

The ICE Dollar Index, which tracks the greenback against a basket of currencies, was at 81.04 compared to 81.253.

A summary of key levels for chart-watching technical strategists is below:

 
Forex spot:       EUR/USD    USD/JPY    GBP/USD    USD/CHF 
 
Spot 1012 GMT     1.2707     80.40      1.5906     0.9452 
3 Day Trend       Bearish    Bullish    Bearish    Bullish 
Weekly Trend      Bearish    Bearish    Bearish    Bullish 
200 day ma        1.3353     79.72      1.5886     0.9100 
3rd Resistance    1.2855     80.91      1.6088     0.9561 
2nd Resistance    1.2813     80.61      1.6051     0.9528 
1st Resistance    1.2742     80.45      1.5987     0.9471 
Pivot*            1.2774     80.11      1.6033     0.9403 
1st Support       1.2681     80.29      1.5880     0.9427 
2nd Support       1.2624     80.15      1.5819     0.9375 
3rd Support       1.2604     79.95      1.5798     0.9300 
 
 
Forex spot:       AUD/USD 
 
Spot 1012 GMT     0.9907 
3 Day Trend       Bearish 
Weekly Trend      Bearish 
200 day ma        1.0352 
3rd Resistance    1.0078 
2nd Resistance    1.0020 
1st Resistance    0.9955 
Pivot*            0.9958 
1st Support       0.9861 
2nd Support       0.9845 
3rd Support       0.9756

-By Eva Szalay, Dow Jones Newswires; 44 20 7842 9305; (eva.szalay@dowjones.com)