Downward spiral accelarated after Standard and Poor’s  downgraded Greece’s government debt to junk status and sliced Portugal’s ratings by two levels.

The downgrades fueled worries that a sovereign debt problem could spread to other areas of Europe, prompting Asian short-term players to sell the common unit and triggering stop-loss selling-orders, dealers said.

In early Asian trading, the European single unit fell to $1.3144, its lowest level since April 29, 2009. Against the yen, the currency dropped to Y122.37, its weakest since March 25.

S&P’s downgrade was a surprise. Although some sort of optimism had emerged toward a possible bailout for Greece late last week, market sentiment has now worsened.

As of 0130 GMT, the euro stood at $1.3186 compared with its New York overnight level of $1.3189. Against the yen, the currency exchanged hands at Y122.82 compared with Y122.83.

The U.K. pound was at Y142.11 and $1.5260, from Y142.14 and $1.5253 respectively late Tuesday. The Australian dollar was at Y85.55 from Y85.23. The New Zealand dollar stood at Y66.33 from Y66.22.

Asian currencies opened lower Wednesday, as traders said jitters on Greece’s downgrade should lead to consolidation moves and profit-taking after recent rallies drove the likes of the Korean won and the Singapore dollar to multi-month highs just days ago.

Against the won, the U.S. dollar soared to a two-week high of KRW1,123 from KRW1,110 late Tuesday. The dollar also rose to a one-week high of MYR3.2180 against the Malaysian ringgit, Asia’s best performing currency so far this year, from MYR3.1850 late Tuesday.

We would expect most emerging market assets and currencies to remain under pressure in the short term at least, all the more since emerging markets have welcomed large capital inflows over the past few weeks.  Still, we remain positive on Asian currencies on economic fundamentals in the longer-term, and it could be the case that in any risk-deleveraging trade Asian currencies outperform other emerging market assets.

The euro may fall to $1.3130 and Y122.00 in the Asian session as regional shares were sharply lower after the Dow Jones Industrial Average closed down 1.9% overnight, dealers said.

Japan’s Nikkei 225 was down 2.8%, Australia’s S&P/ASX 200 was off 1.6% at 4,800 and South Korea’s Kospi Composite was down 1.7%.

With the euro already weakening, “speculators may throw fuel on the fire,” which could accelerate euro-selling, said Motonari Ogawa, a senior dealer at Barclays Capital.

In the near term, the euro may extend its losses to $1.3000 and $120.00 if any negative news about Greek debt issues emerges, reinforcing the view that the euro-zone debt problem may persist for a while, traders said.

Meanwhile, the dollar stood at Y93.13 as of 0130 GMT compared with Y93.12 in New York late Tuesday. The dollar may fall to Y92.70 if share markets stagnate, dealers said. But a further decline will likely be limited as players refrained from more active trading ahead of the outcome of the two-day meeting of the Federal Open Market Committee due later in the day.

Greek assets have taken a hammering after two credit ratings agencies downgraded the euro zone member this month on concerns about its fiscal health, blowing out spreads between Greek bonds GR10YT=RR and safer German alternatives EU10YT=RR to their widest since early April.

Standard & Poor’s also cut Mexico’s credit ratings this week by one notch on fiscal concerns, while worries about Britain’s fiscal and economic health are nagging investors after sterling hit two-month lows against the dollar GBP= this week.

Such fiscal fears could easily chill sentiment for world stocks as the benchmark MSCI world equity index wraps up one of the best annual performances in its 20-year history — up nearly 29 percent. In December however the index has barely made gains.

“Government spending has been the major driver of global growth in 2009 and the capital markets’ challenge to this is a concern,” said Rob Burnett, head of European equities and fund manager at Neptune Investment Management.

“In Europe, Greece is the standout country but the UK, Spain, Portugal and Italy are all experiencing a similar problem. We need to see a calming in fears in relation to government debt for markets to sustainably advance.”

In Dubai, state-owned Dubai World must get creditors of debt worth billions of dollars to reach an agreement to avoid bankruptcy, even though this week’s surprise $10 billion bailout from Abu Dhabi averted a default on bonds held by its property arm Nakheel. Creditors are due to meet on Monday.

Going into the holiday season, investors must be mindful of possible credit rating downgrades and their impact on asset prices as thin liquidity tends to aggravate market moves.

Standard & Poor’s downgraded Greece by one notch to BBB+ this week, saying a further downgrade was possible if the government fails to gain political support for a fiscal consolidation programme. The move came just days after Fitch cut the country to BB-plus, the lowest sovereign rating in the euro zone.

Moody’s, the third big rating agency, has placed Greece’s A1 rating on review for a possible cut.

“It is clear that Moody’s is the least negative on Greece of the main three rating agencies. However, this should by no means be interpreted as a signal that a downgrade is not imminent. The main question is whether the downgrade will be of one or two notches and, of course, the timing will be crucial too,” Ioannis Sokos, strategist at BNP Paribas, said in a note.

Sokos says it is only Moody’s rating that will allow Greek government debt to be eligible as collateral at the European Central Bank in 2011, when the extraordinary liquidity measures by the central bank would expire.