* Euro gains vs dollar on optimism about U.S. budget deal
* Italy yields fall at auction, euro zone sentiment improves
* Dollar gains vs yen may slow
By Anooja Debnath
LONDON, Nov 29 (Reuters) - The euro rose against the dollar on Thursday after comments from U.S. policymakers revived expectations of a deal being reached to avert sharp fiscal tightening in the world’s largest economy.
The euro also gained a boost as Italy’s 10-year borrowing costs hit a 2-year low at a sale of debt on Thursday, helped by the view that a deal this week on Greek debt has eased pressure on other highly indebted euro zone countries.
Traders reported month-end demand for euros, too, but said offers above $1.30 may limit any gains. It was last up 0.3 percent at $1.2991, nearing a one-month high of $1.3010 hit on Tuesday.
U.S. House Speaker John Boehner, the top Republican in Congress, voiced optimism that Republicans could broker a deal with the White House to avoid the “fiscal cliff” of tax hikes and spending cuts due to kick in early next year.
President Barack Obama said on Wednesday he hoped to reach an agreement with Congress before Christmas.
“Some comfort is being drawn from positive news on the U.S. fiscal cliff and is supporting the euro this morning,” said Ian Stannard, head of European FX strategy at Morgan Stanley.
Another positive for the euro were surveys showing economic morale in the euro zone improved in November. However, these positive signs may not be enough to pull the euro zone out of recession.
Some analysts warned the euro was still vulnerable to economic data and concerns about elements of Greece’s aid deal, with Athens’ ability to fully implement a debt buy-back a looming issue.
“Besides the possibility of Spain seeking a bailout, which would be euro positive, there is a greater potential for downside surprises for the euro related to the euro zone economy,” said Steve Barrow, head of G10 currency research at Standard Bank.
Against the yen, the euro was up 0.3 percent at 106.64 yen , not too far from a seven-month high of 107.135 yen hit on Monday.
The dollar edged up 0.1 percent to about 82.09 yen, pulling away from a one-week low of 81.68 yen hit on Wednesday.
The U.S. currency has seen a corrective pull-back since hitting a 7-1/2 month high of 82.84 yen last Thursday when the yen was sold on speculation about possible aggressive monetary easing in Japan after a likely change in government next month.
Main opposition leader Shinzo Abe, a front-runner to become prime minister after the Dec. 16 election, has called for radical change in monetary policy, including unlimited easing, sparking a 4 percent fall in the yen earlier this month.
But some market players were paring back expectations of aggressive easing that would weigh on the yen, and questioned how much impact Abe will have on monetary policy.
SEB analysts said in a note to clients that there was a risk of disappointment after the Japanese election.
However, longer-term they say the yen is vulnerable and could weaken substantially due to high debt and large deficits, although they said higher rates outside Japan may be needed “to trigger a more sustained weakness”.
SEB recommend buying options to buy the dollar at 82.00 yen in six months time.