The Australian dollar is a quarter of a US cent lower as the Spanish government faces the prospect of higher borrowing costs while funding a multi-billion euro bailout of one of its largest banks.
Independent rating agency Egan-Jones said overnight that it cut Spain's sovereign debt rating to BB minus from B.
A Spanish Economy Ministry spokesman said that the government would fund Bankia's recapitalisation after the financial institution asked for 19 billion euros ($A24.44 billion) in financial aid.
The Spanish news encouraged investors to move into safe-haven currencies and the US dollar gained ground against most currencies.
At 5am, the Australian dollar was trading at 98.50 US cents, down from 98.75 cents on Tuesday.
Early on Wednesday morning, the euro went as low as 124.61 US cents, its lowest point since July 1 2010.
HiFX senior trader Stuart Ive said there was a debate over how the Spanish government would finance the Bankia bailout.
"We have a Spanish government that appears to be on a crash course with the ECB (European Central Bank) over how it's going to bail out this bank," Mr Ive said from Auckland.
"In the meantime, the situation for the banks and the country is deteriorating rapidly."
Mr Ive said Spain likely would be the bigger story of the euro zone debt crisis once the Greek elections were held on June 17.
"If Greece leaves the euro zone in two weeks, this will, obviously, be a severe impact initially but it will recover relatively quickly," he said.
"If Greece remains in the euro zone, the market focus will be on Spain and what will be a rapidly deteriorating situation."Mr Ive said the market on Wednesday would focus on the release of retail sales data for April from the Australian Bureau of Statistics.
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