* Euro holds above a 4-month low vs dollar * Greek banks face funding needs, adding to pressure * Spanish bond auction sees strong demand, but sees jump in yields By Philip Baillie and Anirban Nag LONDON, May 17 (Reuters) - The euro held above a four-month low on Thursday, taking a breather from a sharp sell-off, although it was vulnerable to a further slide due to worries about the solvency of some Greek banks and fears the country may exit the euro zone. The common currency was steady around $1.27, hovering above a four-month low at $1.2681 hit on Wednesday, with stop loss sell orders cited below $1.2680. The euro has already shed 3.9 percent in May. More falls could leave it poised to break below chart support at the 2012 trough of $1.2624 reached in mid-January. Contagion fears and jitters over political turmoil in Athens, where politicians rejecting harsh austerity measures are likely to win June 17 elections, have sent the euro and riskier assets like the Australian dollar sharply lower in recent weeks. Dealing another blow to fragile risk appetite, the European Central Bank stopped providing liquidity to some Greek banks because they are severely undercapitalised, moving them to an emergency liquidity assistance programme. Spain managed to sell bonds on Thursday but only by paying much higher yields, raising concerns that borrowing costs may become unsustainable as market worries grow that the crisis could spread to other indebted euro zone countries. Many analysts predict the euro's slide to continue, although some say it could rebound as the market has already priced in much of the risks surrounding Greece. "We wouldn't be surprised to see the euro/dollar going back to $1.30 and stay within the same range within three months - we are pretty much at the bottom of the range," said Pierre Lequeux, head of currency management at Aviva Investors. "Perhaps it could drop to $1.25 if Greece is given the red card by Europe," he said. He added, however, that a Greek exit may be priced in already and pointed out that the euro has traded in an relatively narrow range since January. Minutes of the Fed's most recent policy-setting meeting, released on Wednesday also showed several Federal Reserve policymakers last month thought the U.S. central bank might need to do more to support the economy if the recovery stumbles. That is likely to restrain the greenback which has been one of the biggest beneficiaries of safe-haven flows out of the euro zone. Further quantitative easing by the Fed is considered negative for the dollar as it pushes down yields on U.S. Treasuries. "The market is pricing in a lot of bad news and weaker euro zone structural issues, so there is a chance that the euro will be taking a breather," said Geoffrey Yu, currency strategist at UBS. "Also, the Fed is split and further QE is still being considered, so that should offer some support to the euro." The dollar index - a gauge of its performance against major currencies - eased from a four-month high of 81.573 to last trade at 81.445. The dollar was steady against the yen at 80.34 yen, not far from a two-week high of 80.56. BEARISH GRIP Investors and speculators have built huge bearish positions against the euro since the start of the month after an inconclusive Greek election left the country on the road to bankruptcy and a possible chaotic exit from the euro zone. A Greek departure from the euro area would have a potentially damaging knock-on effect on other ailing economies such as Italy and Spain, whose bond yields have shot higher. Data on Thursday showed Spain contracted by 0.3 percent in the first quarter, putting it firmly in recession after it shrank by the same pace in the fourth quarter. Traders' skittishness towards the euro was visible in the options markets, where one-month euro/dollar implied volatility was last around 10.7 percent, not far from the 2-1/2-month high hit on Wednesday at 11.30 percent. Against the yen, the euro was flat at 102.13 yen, not far from a three-month low of 101.904 yen hit on Wednesday. The euro has shed nearly 7.5 percent since the end of March.

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