Asian stocks fell to multi-month lows and the euro slipped on Tuesday on fears that Europe's sovereign debt woes will trigger a renewed crisis in the continent's banking sector.

Europe's fumbling response to a Greek debt crisis and bulging deficits in other euro zone countries have unnerved markets over the past six weeks, and the central bank takeover of a small Spanish lender at the weekend stoked fears of a wider meltdown.

This situation with the Spanish bank makes investors nervous because it raises suspicions that something else may be smoldering behind the scenes, said Hiroichi Nishi, equity division general manager at Nikko Cordial Securities in Tokyo.

Funding conditions for banks have also been tightening, with firms in the United States increasingly reluctant to deal with firms with large exposure to Europe.

Investors are selling into every rally in the euro, said Jonathan Cavenagh, currency strategist at Australia's Westpac.

Worries about the euro debt crisis are showing signs of spilling over to the banking sector with funding costs rising, albeit from very low levels. All this will only see more demand for U.S. dollars.

Japan's Nikkei average <.N225> fell 2.4 percent, hitting its lowest level in more than 5 months and only around 26 points above a key support level at 9,500. The index has fallen around 16 percent from an 18-month high in early April. <.T>

MSCI's broadest measure of Asia-Pacific shares outside of Japan <.MIAPJ0000PUS> dived 2.9 percent to its lowest in 8 months.

Exporters exposed to the European market were heavy losers, with camera maker Canon <7751.T> down 2.4 percent and rival Nikon <7731.T> falling 5 percent.

In Seoul, where the benchmark index <.KS11> lost 3.6 percent also amid heightened tensions with North Korea, Hyundai Motor <005380.KS> slid 5.4 percent as investors took the opportunity to lock in gains from a rally last month. <.KS>

EURO SQUEEZE

The euro was under pressure as a recent short covering bounce faded. Traders said with liquidity in the foreign exchange market showing signs of drying up, investors were likely to shelter in the relative safe haven of the dollar.

The euro slipped to $1.2315 from around $1.2376 late in New York on Monday, when it lost more than 1.5 percent. Against the yen, the euro eased to around 111.00 from 111.78 on Monday, when it lost more than 1 percent.

The South Korean won fell 4.5 percent to a 10-month low against the dollar amid a sharp rise in tensions on the peninsula after Seoul accused communist North Korea of sinking one of its warships.

The U.S. dollar and the Japanese yen tend to gain when there is a spike in volatility and loss in risk appetite. The dollar index <.DXY> was up 0.6 percent at 86.71.

The worries of a fresh financial crisis boosted the safe haven appeal of gold and U.S. and Asian government debt, with Japanese government bond futures rising to near a two-year high on Tuesday. U.S. Treasury prices had risen on Monday.

June 10-year JGB futures were up 0.25 point at 140.40, not far from a two-year high of 140.61 hit late last week. The benchmark 10-year yield fell 2.5 basis points to 1.225, near a five-month low of 1.220 percent.

U.S. crude futures fell more than 1 percent to below $70 a barrel, erasing the previous day's gains, on concerns the European crisis will choke off the nascent economic recovery. NYMEX crude for July delivery was down 72 cents at $69.49.

Gold weakened in Asia after a rally overnight. Spot gold was bid at 1,190.44 an ounce by 0255 GMT versus $1,194.95 an ounce at 1804 GMT.

Australia Japan Nikkei 225 Fall