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* Euro on track for biggest weekly rise since May 2009
* Optimism as G20 seen tackling euro zone woes
* ECB said to be buying Italian, Spanish bonds
* Traders brush off Spain downgrade, banks on credit watch
* U.S. dollar index set for largest weekly fall since 2009
By Richard Leong
NEW YORK, Oct 14 (Reuters) - The euro rose on Friday on optimism that European leaders were making progress on plans to contain the euro zone debt crisis, despite caution that this week's rally might be overdone.
Group of 20 finance ministers and central bank chiefs began a two-day meeting in Paris on Friday, a day after the euro zone's 17 member nations completed their approval of the expansion of the region's bailout fund.
Although investors do not expect a comprehensive strategy, including steps to recapitalize banks, to come out of Friday's meeting, they hope it will provide an opportunity for officials to agree on the outlines of a plan in time for a European Union summit on Oct. 23.
"Right now we are trading on hopes on a decisive policy response," said Jens Nordvig, head of G10 FX strategy at Nomura Securities in New York.
A report that the International Monetary Fund will present a plan to its executive board to make short-term credit lines available to fundamentally healthy countries hit by liquidity crises also helped support risk appetite.
China, India and other fast-growing economies might contribute to the IMF in its effort to a financial rescue package for Greece. That development also helped revive demand for the euro, which was on track for its biggest weekly gain since January.
"Speculation about the G20 meeting and the IMF playing a part in the solution to the euro zone crisis, combined with technicals, are working in favor of the euro," said Camilla Sutton, Scotia Capital's chief currency strategist in Toronto.
Those hopes, together with talk of the European Central Bank buying Italian and Spanish debt, spurred a recovery in the single currency to $1.3879 from an earlier low of $1.3723 after S&P's downgrade of Spain to AA-minus.
A downgrade of Spain's credit rating by Standard & Poor's late on Tuesday and a decision by Fitch to pub a number of European banks on review for possible downgrades was largely shrugged off by investors on Friday.
The euro touched a session high of $1.3895 on the EBS trading platform after breaking above $1.3838, a key chart level that marks the 50 percent Fibonacci retracement of its August high and October low.
On the week, the euro was up 3.6 percent against the U.S. dollar and was on track for its strongest weekly rise against the greenback since May 2009.
Against the yen, the euro gained 0.9 percent to 106.85 yen , and firmed 0.26 percent against the Swiss franc at 1.2397 francs .
But with no details from European officials yet on a rescue plan to contain the region's debt crisis, the market was seen susceptible to a pullback.
"I'm a little skeptical whether the upside gain is sustainable," said Greg Michalowski, chief currency strategist at FXDD in New York.
The restrained optimism on Europe reduced safe-haven appetite for the U.S. dollar, whose decline against the euro, Australian dollar and other perceived riskier currencies was tempered by surprisingly strong data on U.S. consumer spending.
U.S. retail sales jumped 1.1 percent in September, the biggest rise in seven months.
However, U.S. consumer sentiment unexpectedly deteriorated in early October, a survey from Thomson Reuters and University of Michigan released on Friday showed.
The currency market "is so driven by Europe. If the euro is trading stronger, the dollar is trading relatively weaker," Nomura's Nordvig said.
The U.S. dollar index was down 0.34 percent at 76.73, slightly above its session low. It was on track for its biggest weekly decline since May 2009.
The Australian dollar was up 1.3 percent at US$1.0317 , after triggering reported stop loss orders between $1.0200 and $1.2035.
The U.S. dollar rose 0.2 percent against the yen to 76.990 , below a one-month high around 77.48 yen touched earlier this week.