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Euro gains after successful Spain debt sale, Reuters

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Spain sold 3.75 billion euros of three bonds at the top of the targeted range, sparking relief among investors, although its cost of borrowing was the highest in 14 years and at levels seen as unsustainable for public finances. France also found demand for its sale of 4.35 billion euros of debt in several maturities.

The euro was up 0.35 percent at $1.3485, nearing Wednesday's one-week high of $1.3533, hit after central banks of the United States, euro zone, Canada, Britain, Japan and Switzerland cut the cost of dollar loans to the banking system.

The euro also rose to a two-week high against the yen, but analysts were not convinced the common currency had much scope for further rallies. Although investors cheered Wednesday's joint central bank action they are worried that the euro zone debt crisis remains unresolved, with little time for politicians to find a solution.

A break above $1.3533 could see the euro rise towards its November 18 high of $1.3614. If it fails to retest Wednesday's high, however, the rally may peter out, while traders said the currency may be influenced by a reportedly large options expiry at $1.3500 later in the day.

"The auction went well, adding support to the euro and adding to yesterday's short-covering rally," said Stephen Gallo, head of market analysis at Schneider Foreign Exchange.

"The scope for gains is limited and I can't see many buyers above $1.3500 before the December 9 summit," he said, adding the $1.3500 to $1.3530 area could be a good entry level to put on modest short positions.

The euro has had some reprieve this week as investors have unwound hefty short positions in the euro, helped by signs that Germany and France are pushing for more rapid fiscal integration among euro zone countries.

Currency speculators increased their net short position in the euro to 85,068 contracts in the week ended November 22, the biggest such net short position since June 2010 and pointing to the potential for some short-covering in the currency. <IMM/FX>

"There are such huge short euro/dollar positions that if the markets are able to penetrate resistance levels then the euro might succeed in breaking higher," said Jan Bylov, chief currency analyst at Nordea in Copenhagen.

"But that is the best we can hope for because the action from the central banks will not solve Europe's problems."

European Central Bank President Mario Draghi highlighted the euro zone's fragile outlook, saying downside risks to the economy have increased and that the bank's temporary measures are only limited.


That reinforced a market view that the ECB could cut interest rates and extend its liquidity measures when it meets to decide on monetary policy next week.

"Next week we will have the ECB staff forecasts and we will surely get a substantial downgrade to growth and inflation forecasts," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

"All of which will lead to expectations of a rate cut by the ECB and extension of non-standard measures. The markets will be very frustrated if they don't get that next week."

More important for markets will be whether European leaders are able to agree on a comprehensive solution to tackle the debt crisis at a European Union summit on December 9.

"Expectations are crystallizing that the summit will be make or break time for the euro zone," Schneider FX's Gallo said.

Growth-linked commodity currencies such as the Australian dollar slipped after China's official purchasing managers' index (PMI) showed factory activity shrank in November for the first time in nearly three years and growing expectations of another rate cut by the Reserve Bank of Australia.

The Australian dollar was down 0.4 percent on the day at $1.0237, having jumped about 2.7 percent on Wednesday to a high of $1.0335.

The U.S. dollar index .DXY was down 0.25 percent at 78.179, though off a low of 77.923 hit on Wednesday.

(additional reporting by Anirban Nag; Editing by Catherine Evans)