* Euro falls 1 pct vs dlr <EUR=>; hits 8-yr low vs yen
* Stocks slide sharply, adding to risk pullback
* NZ dollar falls to 9-month low vs U.S. dollar
* Tensions rise in Korean peninsula
(Releads, adds quotes, updates prices)
By Tamawa Desai
LONDON, May 25 (Reuters) - The euro hit a 8 1/2-year low against the yen and neared a 4-year low versus the dollar on Tuesday as concerns about the euro zone's fragile banking system prompted investors to pull back from riskier assets.
Such concerns fanned strains in money markets, boosting demand for dollars across the board.
Weighing on the euro was the Spanish central bank's takeover of savings bank CajaSur on Saturday after a failed merger with another regional lender. [ID:nLDE64L007]
Although CajaSur is relatively small and the Bank of Spain has said it wants to halve the number of ailing small lenders, analysts said the bailout highlighted weakness in the European banking sector and fanned fears more banks may need to be bailed out by some euro zone members.
"Spanish banking fears certainly exacerbate contagion risks," said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ.
U.S. two-year swap spreads pushed out to their widest in two years, reflecting tightening money market conditions.
European shares fell 2.7 percent <.FTEU3>. U.S. stock futures <SPc1> were down 2.6 percent, indicating a sharply lower open on Wall Street after it lost more than 1 percent on Monday.
Tokyo's Nikkei average <.N225> hit its lowest in more than five months, while the MSCI index of Asia-Pacific shares <.MIAPJ0000PUS> outside Japan slid 3.7 percent.
By 0916 GMT, the euro fell 1.2 percent on the day at $1.2200 <EUR=>, nearing a four-year low of $1.2143 hit last week.
Against the yen, the euro fell to 109.36 yen <EURJPY=R>, its lowest since Dec, 2, 2001, according to Reuters charts. The pair was down 1.6 percent from late U.S. trade on Monday.
"Fears are growing that a collapse in confidence could undo the positive growth impulses that are still present, with tensions in money markets resulting in dollar liquidity drying up," said Kenneth Broux, senior market economist at Lloyds TSB.
The euro has lost more than 7 percent versus the dollar this month, heading for its biggest monthly fall since January 2009.
The euro's downside targets stood at the recent low of $1.2143 and at $1.2133, a 50 percent retracement of a rally from its all-time low around $0.8225 in October 2000 to its record peak of $1.6040 touched in July 2008, traders said.
The next support would be the psychologically important $1.2000, where many stops are believed to be set, they said.
Funding conditions for banks have also been tightening.
U.S. dollar 3-month Libor/OIS spreads were sharply wider on Monday, with the 3-month Libor hitting a 10-month high, indicating stressed conditions in the money market.
The dollar index rose 1.2 percent to 87.29 <.DXY>. The greenback dipped 0.4 percent to 89.73 yen <JPY=>.
Growth-linked currencies such as the Australian and New Zealand dollars saw sharp pullbacks.
The Aussie dropped more than 2.2 percent against the yen and 1.5 percent against the U.S. dollar as hedge funds and investors took profits on the higher-yielding currency's rally this year.
Sterling showed little reaction to data showing Britain's economy grew by 0.3 percent in the first quarter of this year, slightly faster than the 0.2 percent initially estimated. [GBP/]
Tensions in Korea buoyed the dollar and yen, after South Korea's Yonhap news agency said North Korean leader Kim Jong-il had told his troops to prepare for combat. [ID:nSGE64O03B]