NEW YORK (Reuters) - The euro rallied from a two-year low against the dollar on Friday, bolstered by a rebound in equities and commodities after China economic data came in less dire than feared, although the currency's outlook remained bleak due to the region's persistent debt uncertainty.
The euro zone's single currency survived a surprise cut in Italy's credit ratings by Moody's, which highlighted the risk that the debt crisis could potentially engulf the bloc's third-largest economy.
But sentiment was buoyed by data showing China's economy grew 7.6 percent in the second quarter, the weakest pace in more than three years, but still better than some outlooks.
"The euro finally caught up with the risk rally that prompted short-covering given that it had been sold off sharply in recent sessions," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.
"But going forward, investors still have a fairly skeptical outlook for the euro and its overall bearish tone leaves it vulnerable to a sell on rallies," he said.
The euro last traded at $1.2238 per U.S. dollar, up 0.3 percent, the currency's best one-day rise so far in two weeks.
It earlier fell as low as $1.2160, its weakest level since mid-2010. The slide in the euro came in the wake of the Moody's Investors Service downgrade of Italy's sovereign debt rating to Baa2, citing doubts over the country's long-term resolve to push through much-needed reforms.
On the week, the euro was down 0.2 percent and off more than 5 percent so far this year - far exceeding 2011's annual loss of 3.2 percent. Declines accelerated after last week's deposit and refinancing rate cuts by the European Central Bank.
"For the most part, it's Friday, the market is thin and everybody is short," said Ronald Simpson, managing director of global currency analysis at Action Economics in Tampa, Florida.
"Euro/dollar has made new daily lows nine days in a row now," he said. "I think it's just a bit of a short-squeeze, driven by various rumors and talk."
Despite the euro's gains on Friday, analysts at ActionForex.com said there is no sign of a bottom yet. Intraday bias remains on the downside, they said, for a test of minor support at $1.2132. A break of that will target $1.1875, the low hit in early June 2010.
On the upside, a break of minor resistance at $1.2333 is needed to signal short-term bottoming, ActionForex said. Otherwise, the outlook remains bearish.
With the euro's gains, implied volatility, a measure of a currency's price movements in either direction, dropped to below 10 percent, its lowest in more than a week, suggesting less anxiety in the near term.
The euro also rose against the Japanese yen, trading 0.2 percent higher at 96.90 yen, but down 0.8 percent this week.
While Moody's warned it could further downgrade Italy's credit rating, now just two notches above junk status, if the country's access to debt markets were to dry up, Italy managed to pass a tough market test as three-year borrowing costs fell well below 5 percent.
Investors also mostly shrugged off data in the United States that showed consumer sentiment cooling in early July to the lowest level in seven months.
Separately, U.S. producer prices rose only slightly last month as energy costs dropped, suggesting inflation pressures remain muted and leaving the door open for more easing by the Federal Reserve. <ID:L2E8ID2PM>
Against the yen, the dollar was last down 0.1 percent at 79.18 yen.
Additional reporting by Julie Haviv; Editing by Gary Crosse