* Italy's Monti says he will quit once budget is passed * Italian turmoil threatens contagion effect on Spain * Fed meeting on Wednesday significant for dollar By Julie Haviv NEW YORK, Dec 10 (Reuters) - The euro rose against the dollar for the first time in four sessions on Monday as comments made by Italy's prime minister allayed fears about the country's outlook, although concerns about the euro zone's near-term prospects kept gains limited. Mario Monti said on Saturday he would resign once the 2013 budget passes. An election in February looks probable, with investors worried about who will navigate the euro zone's third-biggest economy out of the debt crisis. The euro, weighed earlier in the session by a spike in Italy's borrowing costs, rose after Mario Monti tried to reassure rattled financial markets that Italy would not be left adrift following his surprise decision to resign and Silvio Berlusconi's return to frontline politics. Some analysts noted that the bond and currency markets' reaction to Italy's news may have been overdone, given the fact that Monti would have called for elections in a few months time anyway. Monti's decision simply expedites the process. "The markets overreacted to the weekend news and so now we are seeing a pullback and somewhat of a 'risk on' climate," Sebastien Galy, fx strategist at Societe Generale in New York. "We are range trading for the most part and fading some of the euro zone risk," he said. The euro was down 0.1 percent on the day against the yen at 106.52 yen, falling for a third straight day. It dropped as low as 105.94 yen, its weakest in about two weeks. Against the dollar, the euro was up 0.3 percent at $1.2932. Euro resistance remains at the $1.2940 level, traders said, with support at $1.2885 and $1.2860. "Given the chaotic history of Italian politics, it is almost certain that whoever is elected prime minister will not be able to exercise anywhere near the level of control over the country's fiscal policy enjoyed by Mr. Monti," said Boris Schlossberg, managing director of FX strategy at BK Asset Management, in New York. While Italy has nearly completed its planned bond market funding for this year, the latest political turmoil could hinder its ability to borrow around 420 billion euros in 2013. There could also be an impact on neighboring Spain whose government is studying the need for outside help. Concerns about core euro-zone countries also weighed on the common currency. Germany's Bundesbank last week slashed its growth outlook for Europe's largest economy. The euro was also pressured by data showing that Germany posted its narrowest trade surplus in October in more than half a year. FED FOCUS Caution that the Federal Reserve may take fresh steps on monetary easing later this week limited the dollar's advance. The dollar index was down 0.1 percent at 80.334. Many economists expect the Fed to announce on Wednesday monthly bond purchases of $45 billion, signalling it will keep pumping money into the economy to bring down unemployment. That should be bearish for the dollar in general. Bob Lynch, global head of FX strategy at HSBC in New York, said the Fed's likely announcement of further asset purchases on Wednesday may not overly pressure the dollar as the market has already factored it in, but over the longer term, the negative effect would be more pronounced. "We view the Fed's asset purchases and the effective monetization of government debt as debasing to the dollar, undermining its reserve currency status in a manner that will ultimately be reflected in some lowering of its exchange-rate value," Lynch said. The dollar also was pressured by signs that Washington policymakers are no closer to averting the so-called fiscal cliff. Analysts say the tax hikes and spending cuts set to take hold next year could push the U.S. economy back into recession. Data showed speculators' net yen short positions last week rose to their highest since mid-2007. With short bets already stretched, traders said it would be difficult for the dollar to advance against the Japanese currency. The Bank of Japan will probably ease monetary policy next week, sources say, as looming risks such as the potential fallout from the U.S. fiscal cliff and slow Chinese growth continue to cloud the outlook for an economy already seen as in recession. The dollar last traded flat against the yen at 82.32 yen , according to Reuters data.