World stocks fell while the euro headed toward a two-month low on Wednesday on concerns about the euro zone's spreading debt crisis and the potential for a further reduction of positions in risky assets.

Oil prices retreated as the dollar rebounded against the euro and after industry data showed U.S. crude inventories fell less than forecast last week. The euro zone's debt problems drove oil prices down more than 2 percent on Monday.

European equities followed Asian and Wall Street shares down as lingering worries over the economic outlook for the United States as well as euro zone woes weighed on sentiment.

Europe's policy options to avert a Greek debt default appear to be dwindling fast, casting a pall over the single currency and fuelling fears of a chain reaction in other heavily-indebted countries in the 17-nation euro area.

The euro, which had rallied after better-than-expected German business confidence data on Tuesday, edged back toward a two-month low of $1.3968 hit earlier this week. It has lost roughly 5 percent since early May.

The market does not know what to expect next in Greece and clearly there has been a shift in sentiment toward the euro and speculators are preferring to play it the short side, said Gavin Friend, currency analyst at nabCapital.

Speculative selling of the euro intensified on vague market talk that Greece may call a snap election and as investors trimmed risky positions, with a drop in U.S. stock index futures adding to pressure on the euro.

The euro was last down 0.6 percent to $1.4021, well below the previous session's high of $1.4134.

CONTAGION THREAT

World stocks as measured by MSCI shed 0.4 percent with European shares <.FTEU3> falling 0.3 percent as investors fretted over the potential for Greek contagion spreading to bigger economies such as Italy.

Concern about Spain and Italy might be overblown, but the Greece issue is not going away, and if Greece restructures, that may open the door for Ireland and Portugal. said Brian Dolan, chief strategist at Forex.com.

A Greek debt default would hurt other peripheral euro zone states and could push Portuguese and Irish debt into junk territory, Moody's said on Tuesday, warning it would classify most forms of restructuring as a default.

The MSCI's index of Asia-Pacific stocks outside Japan fell 0.7 percent while the Nikkei <.N225> closed down 0.6 percent.

U.S. Treasuries and German Bunds advanced as investors reduced exposure to riskier assets and sought refuge in safe-haven government debt. The 10-year Bund yield hovered just above the psychologically significant 3 percent level and could breach it in the near-term given the unresolved debt crisis.

Oil slid as the dollar rebounded against the euro, giving up some of its 2 percent rise overnight after Goldman Sachs raised its price forecasts for Brent crude. Brent crude for July delivery fell below $112 a barrel.

Gold inched down after having rallied to its highest level in three weeks in the previous session, but bullion priced in euro struck a record high on concerns about the impact of a possible debt default by Greece on other euro zone economies.

Spot gold fell to $1,521.86 an ounce after rising as high as $1,527.45 on Tuesday, its strongest since May 4.

(Additional reporting by Anirban Nag and Sugita Katyal in Singapore)

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