* Euro hovers close to 16-mth low, debt auctions eyed
* Germany sees good demand at 5-year auction
* ECB policy meeting on Thursday, rates expected to stay on hold
By Nia Williams
LONDON, Jan 11 The euro dropped to within sight of a 16-month low against the dollar on Wednesday after Fitch ratings agency said the European Central Bank should do more to resolve the region's debt crisis, prompting nervous investors to sell the single currency.
A senior Fitch official told Reuters that the ECB should ramp up buying of troubled euro zone debt to support Italy and prevent a "cataclysmic" collapse of the euro.
The euro hit a session low of $1.2695, with reported stops triggered around $1.2720 and $1.2700. It held above a 16-month trough of $1.2666 set on Monday on trading platform EBS and there was talk of bids below $1.2700 and also an option barrier at $1.2650.
"The market has moved because of the Fitch story that the ECB must do more to prevent a cataclysmic collapse. From our point of view, the market has been really bearish on the euro and looking for a reason to go short," said Amit Patel, a trader at ETX Capital.
The single currency looked likely to stay under pressure with investors cautious ahead of Spanish and Italian debt sales later in the week that could trigger a sell-off in riskier assets if they go badly.
A German auction of five-year debt, which saw good demand, provided little support to the euro. Germany sold 3.153 billion euros of new five-year 0.75 percent Bobl notes on Wednesday, drawing more demand than in a previous auction in December.
Investors will now focus their attention on Spain, which sells up to 5 billion euros of 2015 and 2016 paper on Thursday, hours before a European Central Bank rate decision. Italy offers up to 4.75 billion euros of five-year bonds on Friday.
"There are still a lot of strains in the market, it is not going to get too euphoric at this stage over a German bond auction. The real uncertainty comes from what is coming up over the next couple of days," said Derek Halpenny, European head of currency research at Bank of Tokyo-Mitsubishi.
Although Italian bond yields edged below the critical 7 percent level seen as unsustainable on Wednesday, Halpenny said the euro would be vulnerable to concerns the debt crisis will intensify in coming weeks as sovereigns refinance.
"Even if Italy gets away a good chunk of its debt over the next couple of weeks it's the financing of this debt at current market rates that is going to be the killer going forward."
Market players were reluctant to initiate big trades before a European Central Bank meeting on Thursday. Policymakers are expected to keep rates on hold at 1 percent and press governments to step up their efforts to tackle the debt crisis.
BROAD EURO WEAKNESS
The euro struggled versus the Australian dollar, hitting a fresh record low of A$1.2347. Against the yen, the common currency fell 0.3 percent to 97.88, not far from an 11-year low of 97.28 yen set on Monday on EBS.
The Australian dollar slipped 0.2 percent against the U.S. currency at $1.0287 after having rallied over the previous two days. The Aussie had risen to as high as $1.0352 on Tuesday, 2 percent up from Monday's low of $1.0145.
"Part of the reason why the Aussie has put on two cents in the last few days is the view that China is going to further loosen policy, which eventually is going to be good for Australian commodity products," said Joseph Capurso, strategist at Commonwealth Bank in Sydney.
"But I think that's overdone and won't be surprised to see the Aussie ease back for the reminder of the week."
The dollar rose 0.2 percent against the yen to 77.02, staying above a two-month low of 76.30 yen hit last week.