FOREX-Euro up on strong Spanish auction, but rally shallow

* Euro rises to two-week high versus dollar and yen
* Stop-losses lurking above, scope for further short squeeze
* Spain bond sale adds to optimism

By Neal Armstrong
LONDON, Jan 19 (Reuters) - The euro rose on Thursday,
supported by a solid response to a Spanish debt auction with an
improvement in risk appetite spurring investors to unwind
bearish positions, although brief rallies are unlikely to break
the single currency's downtrend.
Spain sold 6.61 billion euros of government bonds on
Thursday, more than its announced target, in an auction which
analysts said went well, supported by domestic banks and a
pickup in appetite for riskier assets.
That ensured the euro retained support after hitting
two-week highs versus the dollar and the yen in earlier trade.
Hopes the IMF could boost its resources to help countries
deal with the euro zone debt crisis and some optimism over talks
to avoid a chaotic Greek default were adding to the positive
tone.
"We think the ongoing short squeeze we've seen in the euro
this week can continue. The newsflow we are seeing is reasonably
encouraging for risk with the IMF headlines yesterday and hopes
growing over the Greek restructuring talks," said Tom Levinson,
currency strategist at ING.
Talks between Greece and its creditors are proceeding, but
much more progress is needed before a bond swap to reduce the
country's towering debt pile is reached, three sources close to
the talks said.
The euro was up around 0.4 percent on the day at $1.2902
after traders said stops were triggered on the break of Friday's
high of $1.2879 en-route to a two-week high of $1.2914 on EBS.
More stops were scattered above $1.2900, with scope for another
squeeze of positions and a test of the Jan. 5 high of $1.2946.
A daily close above the euro's 21-day moving average at
$1.2875 would be a positive technical sign, while traders said
an Asian sovereign account sold around the day's high.
"The market is decidedly less short euros than it was but it
is still short and there is scope for a bit of a squeeze from
here," said Chris Walker, currency strategist at UBS.
The euro moved further away from Friday's 17-month low of
$1.2624, with bids reported at $1.2840 and downside stop-losses
through $1.2800.
In the options market, one-month euro/dollar implied
volatilities eased to 11.5 percent from 12.1 on
Wednesday with front-end vols offered due to any large sell off
in the euro.
Against the yen, the euro fetched 99.14 yen after
hitting a two-week high of 99.232 yen on trading platform EBS.
It has gained more than 2 percent since hitting an 11-year low
of 97.04 on Monday.
Still, uncertainty over the euro zone debt crisis would
continue to weigh on the euro and upticks were unlikely to last
long, presenting opportunities to more investors to sell.
"We're not looking for a large rally in the euro and stick
with our forecast of $1.20 by the middle of the year," said
Levinson.
The euro hovered near a four-month low of $1.2080 Swiss
francs, within sight of the Swiss National Bank's 1.20
floor which is likely to be strongly defended if threatened by a
renewed attack on the single currency.

RISK APPETITE
News that the International Monetary Fund is seeking to more
than double its war chest by raising $600 billion in new
resources to help countries deal with fallout from the euro zone
debt crisis improved risk appetite.
Risk appetite was also helped by gains on Wall Street after
Goldman Sachs' earnings exceeded analysts' expectations, even
though they fell sharply, and dispelled some anxiety over bank
profits, though equity futures were treading water.
This week's recovery in the euro helped push the dollar
index to two-week lows at 80.237, down 0.3 percent and
recoiling further from a 16-month peak of 81.784 hit on Friday.
Traders will keep an eye on U.S. consumer price index data that
will be released later in the day.
A soft number could see riskier assets and higher-yielding
currencies gain further at the expense of the U.S. dollar.
Against the yen, the dollar was flat at 76.83 yen.
Traders though had one eye on next week's Bank of Japan policy
meeting for potential action on the Japanese currency given its
recent 11-year high versus the euro and its proximity to record
highs versus the dollar of 75.31.
The high-yielding Aussie dollar slipped to a session low of
$1.0371 after data showed a surprise fall in Australian
unemployment in December.
It last traded at $1.0406, having slipped away from an
11-week high of $1.0450 set on Tuesday.