* Deal reached to spin off Greek units of Cypriot banks
* Euro gains limited by risk of Cyprus banking collapse
* Weaker-than-expected German Ifo index weighs on euro
By Gertrude Chavez-Dreyfuss
NEW YORK, March 22 (Reuters) - The euro rose across the board on Friday on optimism Cyprus will be able to cobble together a last-minute deal that will avert a financial meltdown before a Monday deadline.
The EU has given Cyprus until Monday to raise the 5.8 billion euros it needs to secure a 10 billion euro international lifeline. Without a deal, the European Central Bank will cut funds to Cypriot banks.
On Friday, however, Cyprus moved a step closer to raising those funds by agreeing to spin off Greek units of debt-ridden Cypriot banks. The Cypriot presidency said the deal had been settled with favourable terms for Cyprus.
“We’re seeing large short-covering going on and that’s a huge part of the driver for the euro rally,” said Brian Kim, currency strategist at RBS Securities in Stamford, Connecticut.
“It seems that investors are expecting a deal before the Monday deadline. So they’re not placing new shorts on the euro going into the weekend. They don’t want to be caught on the wrong side of the bet in case a deal does materialize.”
There’s still a long way to go, however. Cyprus’s talks with Russia ended without a positive outcome just yet, but the troubled euro zone government said it has other proposals on the table.
In early New York trading, the euro rose 0.4 percent on the day to $1.2943, with traders citing buying by a UK bank. It hit a four-month low of $1.2843 earlier in the week after Cyprus rejected the terms of a proposed European Union bailout.
Despite Cyprus, the euro was on track to end the week on a positive note, with its best weekly performance since early Feburary.
Strategists, however, said the single currency could struggle to break above $1.30 and would remain vulnerable to developments in Cyprus and the risk of contagion to other euro zone countries.
Nonetheless, market participants don’t seem to be panicking.
“There’s a lot of competing noise from the headlines. The market has been relatively constrained but if we were talking about a bigger country it would be a lot more volatile,” said Simon Smith, currency economist at FxPro.
“The euro has priced in a fair amount of bad news already and there’s still some underlying hope they will stitch something together. But even if we do see Cyprus remain within the euro zone it’s not going to be a massive positive for the euro.”
Smith said he expected the euro to grind lower towards $1.24-$1.25 over the next three months.
Traders expect the euro increasingly to reflect the emerging risks to the euro zone. While the European Central Bank has tools in place to prevent contagion, an exit by Cyprus would still sour sentiment towards European assets.
Earlier in the session the euro hit a two-week low of 121.44 yen after Germany’s Ifo survey of business morale fell short of expectations.. It later recovered and was last trading up 0.3 percent on the day at 122.81 yen.
Asian investors were cited as buyers of short-dated options betting on drops to 121 and 120.50 yen.
The dollar was little changed against the yen at 94.90 yen , having earlier fallen to 94.195 yen. The highly liquid Japanese currency tends to be bought during times of economic uncertainty and heightened financial market stress.
On Thursday the dollar shed about 1.2 percent as investors covered their negative yen bets after new Bank of Japan Governor Haruhiko Kuroda came out less dovish than many had expected.
Gains in the euro saw the dollar index dip 0.1 percent to 82.630, retreating further from last week’s seven-month high of 83.166.