* Euro slides to $1.2666 in thin Asian trade * Short-covering on euro positions provides temporary respite * Merkel, Sarkozy meet; focus on Spain, Italy debt sales By Neal Armstrong LONDON, Jan 9 (Reuters) - The euro crawled back from a fresh 16-month low to the dollar on Monday as traders trimmed short positions, but further declines were anticipated as worries over sovereign funding and prospects for the euro zone economy kept most investors bearish. Markets were awaiting a meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy where they will discuss ways to boost growth and finalise details of a deal to increase fiscal coordination in the euro zone. Sentiment took a further hit over the weekend when German magazine Der Spiegel reported the International Monetary Fund was losing confidence in Greece's ability to clean up its public finances. Also, an adviser to German Finance Minister Wolfgang Schaeuble told a Greek newspaper a 50 percent writedown on Greek debt holdings - a key part of the country's debt swap deal - would not be enough to put its huge debt on a viable footing. The euro hit its lowest level since September 2010 of $1.2666 on trading platform EBS in thin Asian trade, with Tokyo markets shut for a public holiday. Against the yen, the euro hit an 11-year low of 97.28 yen. The single currency later recovered to $1.2780 to trade up around 0.5 percent for the day. "This move up in the euro on the day is just position adjustment as the market is very short euros and that position increased further after Friday's U.S. payrolls," said Lee Hardman, currency strategist at BTM-UFJ. U.S. jobs data last Friday highlighted the diverging growth outlook between the United States and Europe and supported the greenback but Hardman was sceptical over the potential for higher U.S. rates. "The reality is the Fed has made a strong commitment to keep U.S. interest rates low and we don't think stronger U.S. data will be backed with higher rates for the foreseeable future. The dollar is more likely to continue to strengthen from risk aversion," he said. EVENT RISKS Focus in the euro zone this week will fall on Spain and Italy in the run-up to their first bond auctions of the year, with little sign that investors have started 2012 with improved appetite for the euro zone's riskier assets. The European Central Bank also announces its latest decision on monetary policy, with most economists forecasting no change in rates or any fresh liquidity measures after the ECB flooded the financial system with an unprecedented 489 billion euros of ultra-cheap three-year loans in December. Key support for the euro lies near $1.2600, roughly the 76.4 percent retracement of its June 2010 to May 2011 rally and also the late August 2010 low around $1.2690. "Newsflow from the euro zone is not helping, particularly regarding Greece, and markets are also on the defensive ahead of key event risks this week so there's not too much reason to be overweight the euro," said Geoffrey Yu, currency strategist at UBS. "These are testing times for the currency and the scale of the recent decline seems to have caught some people by surprise." Some market players said stop-loss offers exacerbated the euro's drop in Asia on Monday but the fall was meeting with bouts of short covering. Currency speculators boosted short euro positions to record levels in the week ended Jan. 3, data from the Commodity Futures Trading Commission showed on Friday. After finishing 2011 some 13 percent below its year high near $1.4940, the euro has started 2012 on a weak note, having shed roughly 1.9 percent so far in January. The single currency has also fallen to an 8 1/2-year low on a trade-weighted basis, according to ECB data on Friday. The dollar held steady against the yen at 76.89 yen, staying above a two-month low of 76.30 yen hit last week. The dollar eased from a 16-month high against a currency basket of 81.47 in Asia to stand at 80.984.