(Reuters) - The euro strengthened on Tuesday as debt yields of some peripheral euro zone countries retreated, but the bounce could run out of steam if a solution to Greece's debt problem is not found at an EU summit later this week. Traders said official Asian and Russian names bought the euro as yields on Italian and Spanish government bonds retreated slightly following a surge higher in the past week on jitters that the debt crisis is deepening. "The market at the margin is getting a bit more positive on the potential outcome of the European conference (on Thursday). Spreads have come in and euro/dollar is following it," said Geoff Kendrick, currency strategist at Nomura. But Tuesday's gains may be setting the euro up for a fall later in the week if officials fail to reach a lasting agreement on a second Greek bailout and measures to stop the debt crisis engulfing more countries, he said. "It's unlikely you'll get enough of a solution to stop the broad decline in the euro." Kendrick said. Euro zone leaders are trying to finalized a second round of aid for Greece worth 110 billion euros ($154 billion). But it remained unclear how a consensus could be reached for private owners of Greek government bonds -- banks, insurers and other investors -- to contribute by taking cuts in the face value of their holdings. [ The European Central Bank has resisted the possibility of a default, but comments on Tuesday from Austria's central bank governor, Ewald Nowotny, that a solution could involve a 'selective default' was the first sign of a crack in the central bank's hard line. Nowotny later said that he was in complete agreement with ECB President Jean-Claude Trichet on Greece. The euro rose to a session high of $1.42172, after the German ZEW business survey showed a bigger-than-expected rise in current conditions this month, although a sluggish reading of economic sentiment prompted investors to trim gains. Hefty offers above $1.4200 also capped the euro's rise, but it found near-term support after breaking above technical resistance at $1.4111 and $1.4175, the 31.8 percent and 23.6 percent retracements of the euro's rally last week. The euro traded higher against other currencies, gaining as much as 1 percent on the day to a session high of 1.1655 versus the safe-haven Swiss franc. It was helped by reports that Germany plans to hit Swiss banks holding deposits from German tax dodgers with a charge of up to 14 billion euros, rising out of sight of the lifetime low of 1.1365 francs hit the previous day on EBS. RAISE THE CEILING Strength in the euro pushed the dollar, also considered a safer bet during times of uncertainty, lower against a currency basket, with the dollar index .DXY slipping 0.5 percent to 75.077. Against the yen it slipped 0.1 percent to 78.93. Euro gains were the primary driver of a weaker dollar, but analysts said the U.S. currency has also been stung by worries about U.S. fiscal problems. Investors fret that Washington will hit a stalemate over raising the government's $14.3 trillion borrowing limit in the very near future. "Euro/dollar is trapped between the euro zone debt crisis on one side and questions surrounding the U.S. debt ceiling on the other, and the market doesn't want to take on any major positions," said You-Na Park, currency strategist at Commerzbank in Frankfurt. In the options market euro/dollar implied volatilities eased as spot rose but remained elevated at 13.7 percent compared with 13.9 on Monday, a sign that investors see significant event risk and turbulence ahead. One-month euro/dollar risk reversals also traded at 2.8 in favor of euro puts. This greater skew toward the euro's downside means investors are betting the single currency is more likely to fall than rise. (Editing by Anna Willard)

Source