FOREX-Euro gains vs dollar on Spain optimism

* Euro edges back toward 4-1/2-month high, upside limited
* Sources say Spain making plans to meet aid conditions

NEW YORK, Sept 21 (Reuters) - The euro climbed against the
U.S. dollar on Friday, reversing earlier losses, helped by
speculation Spain may soon request financial aid to help ease
the country's debt crisis.
Volume was thin ahead of the weekend, exacerbating
volatility, and traders said the euro may struggle to extend
gains amid uncertainty over the timing of a potential bailout.
Sources with knowledge of the matter told Reuters Spain is
considering freezing pensions and speeding up a rise in the
retirement age as it attempts to meet conditions of an
international aid package.
German Finance Minister Wolfgang Schaeuble dented
expectations by saying on Friday that Spain did not need a
sovereign bailout on top of the package already agreed for its
banks because it was on the right path to regain the confidence
of markets.
"Reports of a Spanish deal as soon as next week helped to
boost sentiment and the euro. The market remains prudently
bullish buying on dips," said Sebastien Galy, currency
strategist at Societe Generale in New York.
The euro rose 0.1 percent to $1.2987, having hit a session
high of $1.3047 on Reuters data, not far from a
four-and-a-half-month peak of $1.3169 set on Monday.
The dollar slipped 0.1 percent to 79.3331 against a
basket of currencies, within sight of a six-and-a-half-month low
of 78.601 hit last week in the wake of aggressive monetary
easing by the Federal Reserve.
Carl Hammer, chief currency strategist at SEB in Stockholm,
said the euro may rise to $1.31 or slightly higher over the
coming month but would peak at not more than $1.34-$1.35 because
Spain applying for funding would be "the last piece of
euro-positive news."
Spain, the new epicenter of the euro zone debt crisis after
Greece, Ireland and Portugal, has been hesitating to apply for
external aid, creating uncertainty in the markets. Its borrowing
costs fell on Thursday at a debt auction but the relief may be
short-lived.
The European Central Bank pledged this month to buy
shorter-term bonds of troubled euro zone members but only after
they first apply for assistance.
"The risk is that if they don't (seek a bailout) investors
will panic out of their newly bought Spanish bonds," Societe
Generale's Galy said.
Even if Spain does request assistance, analysts say it may
not be a positive sign for the euro as the tough spending cuts
that come with the aid would put further pressure on an economy
already in recession.
There are also concerns surrounding Greece, with negotiators
still short of a deal that would unlock the next installment of
the country's 31.5-billion-euro bailout package.
The dollar fell 0.2 percent to 78.10 yen, well below
a one-month high of 79.21 hit on Wednesday after the Bank of
Japan boosted its asset-buying program to support the country's
economic recovery.
Sterling rose to its highest in nearly 13 months
against the dollar, helped by UK public borrowing data that was
not as bad as expected. It was last at $1.6246,
up 0.2 percent.
The high-yielding Australian dollar climbed 0.2
percent to $1.0448.
The euro's losses earlier in the session came after reports
that the Swiss National Bank sold the currency against the
Australian dollar as part of its long-term diversification drive
to recycle its inventory of euros into higher-yielding
Australian dollars, said Boris Schlossberg, managing director of
FX Strategy at BK Asset Management.
Schlossberg said the euro's rebound could also be attributed
to sovereign fund demand out of the Middle East.
The euro fell 1 percent against the dollar for the week, its
worst week since July 8, while the dollar slipped 0.4 percent
against the yen over the same period.