Euro survives Italy worry, Fed in focus

A picture illustration shows euro banknotes outside the European Commission headquarters in Brussels November 28, 2011.

SYDNEY (Reuters) - The euro extended its recovery from a two-week low on Tuesday as nerves calmed over Italy's latest political turmoil and the prospects of more stimulus from the Federal Reserve pinned down the dollar.

The common currency stood at $1.2940, having climbed off a low around $1.2880 plumbed on Monday. It has risen some 0.5 percent from Friday's two-week trough around $1.2876. Immediate resistance is seen at $1.2973, a level representing the 38.2 percent retracement of its December 5-7 fall.

The euro found some support after Italian Prime Minister Mario Monti played down market fears over his decision to resign, saying there was no danger of a vacuum ahead of an election in the spring.

"The euro's dip below $1.2900 proved to be short-lived," said Vassili Serebriakov, strategist at BNP Paribas. "FX markets are showing some notable resilience following news of Italian PM Mario Monti's imminent resignation."

Another factor keeping the euro off its lows was a reluctance by investors to aggressively buy the dollar, given expectations the Fed will replace its expiring 'Operation Twist' program with another Treasury bond-buying plan at its December 11-12 policy meeting.

Many economists believe the U.S. central bank will announce monthly bond purchases of $45 billion, although some think it could surprise with a bigger amount to press borrowing costs lower. Such an outcome could see the greenback come under further pressure.

The dollar index .DXY slipped 0.1 percent to 80.311, retreating from at two-week high of 80.658 set on Monday.

The dollar was buying 82.37 yen, still within easy reach of an eight-month peak of 82.84 set last month.

The prospect of fresh stimulus from the Fed and growing expectations the Bank of Japan could expand its asset-buying and lending program at a meeting next week kept high-yielding currencies well bid, despite worries that bullish positions were already stretched.

The Australian dollar stayed comfortably near an 11-week high of $1.0515 set last week, while the New Zealand dollar reached a near three-month high of $0.8355.

"We have touched the AUD/USD 1.05/1.06 region in which we would sell, but are yet to enter it more firmly," said Sebastien Galy, strategist at Societe Generale.

There is no major economic data out of Asia on Tuesday. In Europe, the focus is likely to be on the monthly German analyst and investor sentiment survey from the Mannheim-based ZEW think tank.

(Editing by John Mair)