AppId is over the quota
* Euro lifts off four-month low vs dollar, eyes 2012 low
* Broad demand for safe havens supports dollar and yen
* Greek politics, Spanish bank problems weigh on sentiment
By Anirban Nag
LONDON, May 18 (Reuters) - The euro lifted off a four-month low against the dollar on Friday, as investors pared bearish bets after earlier falls but concerns about a Greek euro exit and instability in the Spanish banking system were likely to keep it under pressure.
Investors preferred the relative safety of the U.S. dollar and the Japanese yen and were reluctant to buy riskier assets after Moody's cut the credit ratings of 16 Spanish banks on Thursday.
The euro tumbled to $1.2642, not far from its lowest of the year, before recovering to trade 0.2 percent higher at $1.2715. Traders cited large option expiries at $1.2700 which were likely to cap gains.
Some traders said the euro's recent decline could slow, given investors may be wary of holding positions over the weekend when leaders of the G8 major industrial economies meet.
The euro, down 4.1 percent against the dollar so far in May, was on track for its third straight week of losses. On the other hand, strong demand for the greenback helped the dollar index to a four-month high of 81.758.
The euro fell to 100.219 yen, its lowest since early February before recovering.
Strategists said the euro would remain vulnerable to further bad news out of the euro zone, and looked set to test the 2012 trough. A break below there would take the euro to its weakest level versus the dollar since August 2010.
"If it's not Greece, it's Spain that we talk about to sell the euro. People are looking for bad news and they are concerned there appears to be no solution," said Lutz Karpowitz, currency analyst at Commerzbank.
Greece faces fresh elections on June 17, with many investors increasingly concerned a victory for anti-bailout parties could lead to Greece exiting the euro zone.
A recent poll showed Greece's conservatives have overtaken the anti-bailout leftist SYRIZA in popularity, although the volatile political mood meant most analysts saw the outcome of the elections as a significant risk.
Worries about Spain's banks and prospects of more state bailouts for lenders kept the country's borrowing costs high.
POLICY RESPONSE
Talk of a ban on naked short-selling of Spanish banking stocks lifted Europe's bank shares and this brought some respite to the euro, but the common currency's medium-term prospects remained bearish.
Reflecting that, one-month euro/dollar implied volatility climbed to around 11.70 percent while three-month risk reversals - a measure of relative demand for bets on the euro rising or falling - were at 3.4 vols in favour of more euro weakness.
"A lot of bad news is already priced in by now - it depends what happens in Greece and, of Spain, whether there will be a further decline in bank deposits - if that would happen then you would expect euro/dollar to go down," said Jaco Rouw, fund manager at ING Investment Management.
No economic policy decisions are expected from the G8 but officials said U.S. President Barack Obama hoped to promote discussion on steps to resolve the euro zone crisis.
The dollar was flat against the yen at 79.35 yen and well above a three-month low of 79.13 hit on Thursday. Traders cited stop losses orders below 79.00 yen and 78.80 yen, while offers were likely to cap dollar gains around 79.50.
© Thomson Reuters 2011. All rights reserved.
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