* Euro retreats from two-week high on profit-taking
* On track for biggest weekly rise in 3 months, $1.30 eyed
* Cautious optimism on Greek debt swap talks
By Nia Williams
LONDON, Jan 20 (Reuters) - The euro retreated from a two-week high against the dollar on Friday as some investors took profit on a short-covering rally but looked likely to find support on cautious hopes Greece may be nearing a deal to avoid a chaotic debt default.
The single currency has gained 2.4 percent so far this week and was on track for its biggest weekly rise in since October after solid bond auctions in Spain and France on Thursday boosted risk appetite.
Cautious optimism on a Greek deal helped the euro to a two-week high of $1.2986 in early London trade, well off the 17-month low of $1.2624 hit last week. It was last down 0.2 percent at $1.2930 as some investors booked profts on the rally.
Market players said position unwinding might give the euro a further lift in the near-term and push it through reported offers around $1.30, although further gains above that level could be difficult.
“This is not only about Greece, we have definitely had a risk-on move and we know there are a lot of euro/dollar shorts in the market. I expect we will breach $1.30 today but run out of steam if the rally goes much higher,” said Lutz Karpowitz, currency analyst at Commerzbank.
Many analysts said although the euro was likely to be supported in the short-term investors would be wary of driving the single currency too high given the risk of the Greek talks breaking down.
Greece and its private bondholders resume debt swap talks on Friday amid signs they are inching closer to a deal that will pave the way for a fresh injection of aid before 14.5 billion of bond redemptions fall due in March.
A positive outcome to the talks could boost the euro, while any negative news could see investors re-establish bearish bets.
“If the Greek debt talks do break down, clearly that is going to be one of the risks to the euro/dollar,” said Mitul Kotecha, head of global foreign exchange strategy for Credit Agricole in Hong Kong.
“I suppose markets will look for any sign that the talks are progressing today to help to sustain the rally in euro.”
Against the yen, the euro was down 0.1 percent at 99.86, having rebounded since hitting an 11-year low of 97.04 yen on Jan. 16.
Aside from the risk of a messy Greek default, market players still see downside risks to the euro in coming months, due to concerns that the euro zone economy may slip into recession and limit progress toward fiscal consolidation in the region.
The euro and the risk-sensitive Australian dollar took in their stride a signal showing that China’s manufacturers started 2012 in a sluggish mode.
The HSBC flash manufacturing purchasing managers index (PMI), the earliest indicator of China’s industrial activity, stood at 48.8 in January, below the 50 level that demarcates expansion from contraction.
Still, it came in at a three-month high and was a slight improvement on the 48.7 final reading of the December index.
The Australian dollar eased 0.1 percent to $1.0402, hovering near an 11-week high of $1.0450 hit earlier this week.
The dollar was stuck near a two-week low against a basket of currencies, in the wake of the euro’s recent rally.
The dollar index stood flat at 80.234, having dipped to 80.041 the previous day, its lowest level since Jan. 4.
Against the yen, the dollar rose 0.1 percent at 77.21 yen , hovering near the top end of its 76.30 yen to 77.342 yen range seen so far in January.