* Euro recovers, but Spanish uncertainty weighs * Likely Moody's downgrade could push Madrid to seek bailout * Euro zone PMI not as bad as earlier estimates By Nia Williams LONDON, Oct 1 (Reuters) - The euro recovered after hitting a three-week low on Monday as euro zone manufacturing data came in less bad than expected, but doubts about Spain's progress towards a bailout dampened demand. Data showed France's manufacturing sector deteriorated sharply in September, while the Purchasing Managers' Index (PMI) for Europe's largest economy, Germany, rose to 47.4 in September. The German reading was the highest since March, but still below the 50 line that separates growth from contraction. The PMIs for Italy and Spain were not bad as expected, providing some relief for the euro, which has been beset by worries about sovereign debt and the banking sector. The common currency rose 0.3 percent to $1.2895, although some analysts said its resilience was due less to confidence in the euro zone than to dollar weakness after the U.S. Federal Reserve unleashed another round of monetary easing last month. "People are finding excuses to buy the euro because they do not particularly want to be long dollars and risk being bitten by the Fed," said Jane Foley, senior currency strategist at Rabobank. "These concerns about Spain could drive euro/dollar a bit lower and we could see $1.26, but if we do get back there we won't stay there for long." The euro hit a three-week low of $1.2804 in Asian trade, breaking below support at its 200-day moving average at $1.2823. A daily close below $1.2823 could signal further weakness ahead. Investors were awaiting the outcome of credit agency Moody's review of Spain's sovereign rating. Europe's fourth largest economy may be downgraded to junk status, piling pressure on it to seek an international bailout soon. An independent audit released on Friday showed Spain's banking sector would need 59.3 billion euros in additional funds to cope with an economic downturn. Spain said only 40 billion euros would come from European aid while the rest could be raised by the banks themselves. "We will see the euro head lower until Spain applies for a bailout and the probability of that happening could rise if Moody's downgrades Spain," said Adam Myers, senior foreign exchange strategist at Credit Agricole. "A downgrade could force Spain's hand in seeking a bailout and should see a relief rally in the euro. But until that happens, weak economic data will add to the downward pressure on the euro." DOLLAR WEAKNESS Speculators boosted bets against the dollar in the latest week to the highest in more than a year, according to data from the Commodity Futures Trading Commission released on Friday. The dollar edged up 0.1 percent against the yen to 77.97 yen, off a more than two-week low of 77.43 yen hit on Friday. The euro rose 0.2 percent against the Japanese currency to 100.45 yen. The Bank of Japan's quarterly tankan survey of business sentiment released on Monday showed big Japanese manufacturers expect the dollar to average around 79.06 yen in the fiscal year through March 2013. The survey also showed the mood among major manufacturers worsened in the latest quarter and was likely to stay gloomy, dragged down by weak Chinese and European demand. Data on Monday showed China's factory purchasing managers' index rose to 49.8 in September from August's 49.2. The figure was in line with expectations but pointed to a continued contraction in activity. Unease about Spain's situation as well as lacklustre Chinese data pressured commodity currencies, with the Australian dollar slipping about 0.2 percent to $1.0355, after hitting a three-week low of $1.0326.

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