Analysts said news of a contraction in Germany's gross domestic product and a fall in French industrial production raised concerns about the credibility of Europe's central bank as well as the prospects for the 11-nation euro-zone's economy.

The fledgling currency, which just seven weeks ago was heralded as a potential rival to the mighty dollar, was facing doubts that the upstart unit would live up to its promise.

"It is difficult to find reasons to buy the euro at the moment," said David Coleman, chief economist at CIBC Wood Gundy in London.

"At the moment, the euro is really just a one way bet and that is down. It is turning out to be a weak currency, hampered by political interference with monetary policy."

The euro was now paying the price for the European Central Bank's "wrong" decision Thursday not to cut interest rates, Coleman said. He said the move, although designed to convince the markets that the ECB had a firm grip on euro-zone inflation and monetary policy, in fact had the opposite effect.

"The desire to have credibility only makes sense if you have some in the first place," Coleman said adding that the ECB's refusal to cut rates in the face of overwhelming evidence of an economic slowdown in Europe smacked of politics rather than economics.

Coleman said the euro, which has fallen around 6 percent against the dollar since its January 1 launch will remain under pressure as investors flock to the U.S. unit ahead of this weekend's Group of Seven meeting of finance ministers and central bank governors.

The globe's top seven industrial nations are expected to discuss supervision of financial institutions and speculative hedge funds, among other things.

Coleman believes the U.S., tired of being the only guarantor of world growth, may criticize the ECB and Europe for not doing more to stimulate growth in the region.

"The U.S. is becoming a bit impatient and wants to see other regions contribute their share (to world growth)," Coleman said.

"A weak economic background and questions about ECB credibility are of course not at all helpful for the euro."

Stocks in Europe initially rose, buoyed by Wall Street's 100-point plus advance overnight but these gains quickly evaporated after news that German gross domestic product had contracted by 0.4 percent in the fourth quarter of last year compared with the third quarter.

The data confirmed economists' estimates that Europe's largest economy contracted at the end of last year as the Asian and Russian financial crises began to dampen export growth.

News that French industrial production, excluding construction, had dropped by 1.6 percent in December versus a rise of 0.1 percent in November also hit market confidence.

"European stocks continue to defy the laws of economic gravity," said David Brown, chief European economist at Bear Stearns in London.

He said gathering evidence of a looming euro-zone recession had been ignored for too long by stock markets and this could result in a snap back in prices.

The dollar rose to a 12-week high against the struggling Japanese yen in Tokyo Friday but was off its highs as profit takers entered the market after the U.S. unit touched 120.75 yen, its best level since December 2.

Earlier comments by Japanese officials had seemed to endorse yen weakness. Economic Planning Agency head Taichi Sakaiya said the dollar around 120 yen was appropriate when looking at the foreign exchange basis used in the government's economic outlook.

Sterling was hovering close to a record high against the euro as the market took the view that the ECB is likely to cut interest rates before the Bank of England.

"The pound's strength is driven by euro weakness and the feeling that we're heading toward European rate cuts," a currency trader at a major U.S. bank said.

In Tokyo Friday, stocks dipped for the third straight session as concerns corporate Japan would unwind cross shareholdings before the end of the fiscal year outweighed incentives of a weaker yen and strong bonds, traders said.

The Nikkei 225 index closed 48.75 points lower at 14,098.04.