* Euro climbs after Italy auction, boosted by short covering * Analysts warn debt crisis still acute, euro vulnerable * Finance ministers meeting in Brussels has scope to disappoint By Nia Williams LONDON, Nov 29 (Reuters) - The euro rose sharply against the dollar on Tuesday, boosted by relief among investors that Italy managed to sell government bonds to the market even though it was forced to pay record high auction yields. Traders said speculation of good demand at the auction started to drive the euro higher ahead of the results, while buying by hedge funds also drove the single currency higher. The euro was last up 0.6 percent on the day at $1.3391. It hit a session high of $1.3442 after breaking through reported stop loss orders at $1.34 and $1.3415. Traders cited further stops building around $1.3450-60. Italy sold 7.5 billion euros of three- and 10-year government bonds, close to the upper end of its target range. Analysts said that although the yield on new three-year Italian government bonds soared to almost 8 percent, a level seen as unsustainable in the long-term, some market players had been concerned Italy would struggle to shift the bonds at all after weak demand at a German auction last week. "Market expectations (of the auction) were very low. The market is very short euros going into month-end so I am not surprised by the move," said George Saravelos, G10 FX strategist at Deutsche Bank. "The bounce has not been that big so far, so we might see a bit more short-covering. But I am still bearish on euro/dollar because I think the euro zone situation is still clearly very serious." Deutsche Bank expect liquidity to deteriorate into year end and forecast the euro to be around $1.25 by the middle of 2012. The rally helped the single currency consolidate the previous day's gains, when the euro rose on cautious optimism European policymakers could make progress in tackling the debt crisis this week. Euro zone finance ministers meet later on Tuesday to approve detailed arrangements for scaling up the EFSF rescue fund to help prevent contagion in bond markets. They are also expected to release a vital aid lifeline for Greece. Germany and France reportedly aim to outline proposals for a fiscal union before a European Union summit on Dec. 9, which a growing number of investors see as perhaps the last chance to avert a breakdown of the single currency area. But strategists warned that the euro remained vulnerable to renewed selling unless investors see concrete action, given they have been disappointed by policymakers in the past. Some traders said markets were simply looking for an excuse to cut bearish positions on the euro and commodity currencies, after going short risk last week. "Finance ministers will meet in Brussels, but the net result could be quite disappointing so we see further pressure on the euro," said Lutz Karpowitz, currency analyst at Commerzbank. The euro showed little reaction to a report on French newspaper La Tribune's website saying Standard & Poor's could change the outlook for France's triple-A rating to negative within the next 10 days. There was also little reaction to news that Fitch had cut the United States' credit outlook to negative, although it expected no move on the actual rating until late 2013. RISKIER CURRENCIES RALLY Perceived riskier currencies rallied in line with the euro and equities following the Italian auction. The Australian dollar climbed nearly 2 percent to a session high of US$1.0078, with some resistance seen around the 21- and 55-day moving averages around US$1.0096-8. Amid broad dollar selling, the greenback reversed earlier gains against the yen to fall 0.3 percent to 77.69 yen, while the euro managed to extend gains versus the Japanese currency, last trading up 0.4 percent at 104.21 yen. The dollar index fell 0.8 percent to 78.657. Data from the U.S. Commodity Futures Trading Commission shows currency speculators raised their bets in favour of the U.S. dollar to the highest level in five weeks in the week ended Nov. 22. The same data also showed speculators increased their bets against the euro from a week earlier, suggesting that short-covering may lend the euro support.

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