* Italian bond sale solid, but borrowing costs rise
* Bernanke reiterates support for Fed stimulus
* Options market shows bias for euro weakness
* SNB says far from ending policy of currency cap
By Gertrude Chavez-Dreyfuss
NEW YORK, Feb 27 (Reuters) - The euro rose against the dollar on Wednesday, bolstered by solid demand for Italy's first bond sale since its general elections, but the current political uncertainty in the euro zone's third-largest country will likely contain any upside.
Robust demand for Italy's bonds despite a rise in the country's 10-year debt costs helped spur buying in the euro, which had fallen nearly 1.0 percent against the dollar on Monday in the wake of Italy's inconclusive elections.
The country is fueling renewed concern about a possible re-emergence of the euro zone debt crisis. Doubts about Italy's ability to reform its indebted economy resurfaced as the weekend elections showcased the lack of popular support for austerity policies and resulted in a hung parliament.
"The uncertainty in Italy does not bode well for the Italian economy which is going through a tough recession as it is. It does not need yet another stumbling block while trying to recover," said Sean Cotton, vice president and foreign exchange advisor, at Bank of the West in San Ramon, California.
The euro last traded at $1.3125, up 0.5 percent on the day.
It briefly pared gains after European Central Bank President Mario Draghi said on Wednesday the bank is far from exiting its easy monetary policy as the recovery in the euro zone is going slowly. Draghi made the remarks in Germany.
The euro also found support from a survey showing euro zone economic and business confidence improved for a fourth straight month in February.
Technical strategists said there would be support for the euro at this year's low of $1.2998, and below that around the Dec. 7 low of $1.2876.
The euro held above Tuesday's trough of $1.3017, which was its weakest since Jan. 7. Strategists say further losses are likely as uneasy investors wait to see whether Italian politicians can form a coalition, or will call fresh elections.
Jay Meisler, founder and co-partner of GlobalView.com in Huntington, New York pointed out that the $1.31 level is crucial, having risen to that level several days in a row. He added investors will normally look at these gains as bear market rallies unless the euro gets to the $1.3150-$1.3200 range.
"Typically, after a big move like this, you need to shake out weak shorts before a fresh assault on the downside," Meisler said.
In the options market, the one-month euro/dollar risk reversals had shown on Tuesday their highest bias for euro weakness since late June as investors bought euro put options - bets the currency will weaken. Risk reversals had flipped to euro calls - bets it will rise - toward the end of last month.
Also on Wednesday, Federal Reserve Chairman Ben Bernanke in testimony to the U.S. House of Representatives reiterated his comments the previous day before the Senate that the central bank would keep buying bonds for some time. The remarks have helped alleviate some market concerns about an early end to the Fed's easing program.
The safe-haven yen fell against the dollar as risk appetite increased.
The U.S. dollar last traded at 92.31 yen, up 0.3 percent, above a one-month low of 90.92 but below a 33-month high of 94.76 touched on Monday. The euro stood at 121.14 yen , up 0.8 percent on the day.
The yen has been one of the worst performing major currencies so far this year as investors bet on more aggressive policies from the Bank of Japan to beat deflation, and positioned for more monetary stimulus.
Strategists said the yen's strength will likely be temporary given demand among Japanese investors for higher-yielding foreign assets.
The British pound is also one of the weakest currencies this year. British government bonds rose on Wednesday after a top central banker said Britain's economy might need more bond purchases over a longer period than before.
Elsewhere, the Swiss National Bank is far from abandoning its policy of capping the strong Swiss franc, Chairman Thomas Jordan said on Wednesday, pointing to new risks from the indecisive outcome of the Italian election.
The euro last traded at 1.2222 francs, up 0.4 percent on the day.