(Recasts after inflation data, adds details, fresh quotes)
* Short squeeze after inflation data helps euro bounce
* Euro trade-weighted index at 13-month lows
* Dollar index steady
By Anirban Nag
LONDON, Aug 29 (Reuters) - The beleaguered euro won temporary relief on Friday after euro zone inflation came in line with expectations and somewhat cooled speculation that the European Central Bank would ease monetary policy as early as next week.
Nevertheless, it was on track for a second straight month of losses as euro zone annual inflation has fallen to a five-year low of 0.3 percent - well below the ECB's danger zone of 1.0 percent. This is likely to keep alive expectations of more dovish comments from ECB chief Mario Draghi when he speaks after a policy rate decision on Sept. 4.
The euro was trading firm at $1.3190, having risen to a day's high of $1.3195 soon after the inflation data, and above the one-year low of 1.31525 hit on Wednesday.
The single currency has lost 1.6 percent in the past two weeks, partly due to the conflict in Ukraine and Russia, which is likely to weigh on growth in the euro zone. The sell-off accelerated after Draghi's speech last Friday at Jackson Hole.
Draghi said the ECB was prepared to respond with all its "available" tools if inflation slows further, triggering speculation that the bank was likely to resort to asset purchases, or quantitative easing.
That drove euro zone bond yields to record lows and with overnight inter-bank lending rates trading below zero for the time ever, rate differentials are moving against the single currency and keeping a lid on its gains.
"The inflation data has provided a bit of relief for the euro, but a confluence of factors are coming together - from deflation in Italy, to weak German retail sales, to negative EONIA rates - that will keep the euro weak," said Jeremy Stretch, head of currency strategy at CIBC World Markets.
"It is only a matter of time that the euro tests last September low of $1.3105."
Data on Friday showed Italy's harmonised consumer price index falling 0.2 percent month-on-month, with the year-on-year rate also dropping 0.2 percent, confirming fears of a deflationary spiral.
German data showed that retail sales fell 1.4 percent in July from a month earlier, much worse than expectations. All of which meant that the euro would struggle to build gains.
Indeed, the euro was subdued near a 21-month low against the Swiss franc and a two-week low against the pound >. The euro trade-weighted index was near its lowest since July last year.
"While month-end flows could help the euro squeeze some more, the bounce should be ultimately used to add to shorts ahead of the ECB meeting next week," said Valentin Marinov, currency strategist at Citi.
In contrast to the euro zone, the U.S. economy rebounded more strongly than initially reported in the second quarter, revised data showed, and a bigger chunk of the growth was driven by domestic demand. The revision highlighted the difference in U.S. and euro zone monetary policy outlooks.
The dollar index was steady at 82.477, not far from its 13-month peak of 82.727 hit on Wednesday. Investors are looking for August Chicago PMI and the University of Michigan Confidence Sentiment readings later in the session, along with personal spending and income data for July.
The dollar rose against the yen. It was trading firm at 103.95, though below a recent high of 104.49.
Japanese economic data had little effect on the yen. The reports showed a rise in the jobless rate and weaker-than-expected growth in industrial output. (Editing by Mark Heinrich)