* Euro suffers after Fitch threatens 2-notch Italy downgrade * Analysts see more losses if Greek debt talks break down * Investors await Portugal bill sale, strong demand expected By Naomi Tajitsu LONDON, Jan 18 (Reuters) - The euro trimmed gains on Wednesday after a warning from a ratings agency of more downgrades to Italy underlined the extent to which weak euro zone countries are suffering from the region's debt crisis, which could knock the currency lower. Comments from Fitch that a two-notch downgrade of Italy was an option snuffed out a short-covering rally in the single currency seen earlier in the day. A cut in bets to sell has boosted the euro all week, lifting it from a 17-month low hit versus the dollar late last week. But investors believe the euro will remain vulnerable to more evidence of fiscal and economic weakness in the region, and see more selling if Greece is unable to reach a debt deal with its creditors, which would raise the chance of default. "Greek bond negotiations could trigger more euro weakness as they have to close a deal soon, before Greek debt repayments are due in March," said Richard Falkenhall, currency strategist at SEB in Stockholm, referring to talks beginning in Athens on Wednesday. "If they don't come up with a solution soon, it could result in more euro weakness." Traders said the euro was being driven by the comments from Fitch, which came just days after rival S&P on Friday cut its credit rating for Rome and eight other countries. S&P on Monday cut its AAA rating of the EFSF European bailout fund. The euro traded at $1.2755, up a touch on the day, but hovering near a session low of $1.2734. It fell from a session high of $1.2808, and remains in range of $1.2624 hit on Friday, its weakest since August 2010. Traders said demand from Russian and Mideast names, along with a real money fund, had boosted the single currency in early European trade, while adding that Asian sovereign names had sold the single currency at the session peak. The euro pulled back further on the Fitch comments, while stop-loss orders in the mid-$1.2700 region accelerated its downmove. The comments also put the euro under selling pressure versus other currencies, keeping it near an 11-year low against the yen and a record trough versus the Australian dollar. The dollar was a beneficiary of the euro selling. Against a currency basket, the dollar traded 0.2 percent lower at 81.061, clawing back from an early slide to 80.778. Given its status as the world's most liquid currency, the safe-haven dollar tends to appreciate during times of uncertainty. Against the yen, the U.S. currency was little changed at 76.70 yen. AUCTIONS AHEAD Investors awaited auctions of Portuguese bills later in the day to see how much demand Lisbon will attract for three-, six- and 11-month paper as it struggles to improve its debt standing. The country aims to sell up to 2.5 billion euros in its biggest debt auction since last year's bailout. Many analysts believe the auction will go without a hitch due to demand from domestic banks. A large take-up of three-year ECB loans last month is believed to have left euro zone banks with funds to invest in domestic debt auctions. At the same time, some analysts argue that weak bond auctions could have limited impact on the euro going forward. "Upcoming auctions need not disrupt the recent modest recovery in EUR and decline in risk premia," Citi analysts said in a note. "A sharp EUR sell-off in response to a weaker auction would be a break from the recent precedent. Germany is looking to raise around 4 billion euros in the bond market on Wednesday, followed by Spain and France on Thursday.

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