By Naomi Tajitsu and Nia Williams LONDON, Nov 29 (Reuters) - The euro rose 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. It trimmed gains after the European Central Bank failed to attract enough deposits from banks required to offset its purchases of bonds from debt-ridden euro zone countries as a continuation of such a shortfall would in effect be a form of quantitative easing. Traders were also sceptical of the euro's earlier gains as while the auction showed Rome remains able to borrow from the market, its funding problems are far from being solved as the euro zone debt crisis deepens. Italy managed to sell 7.5 billion euros in three- and 10-year government bonds, although it was forced to pay a yield of nearly 8 percent to borrow through 2014, a level seen driving its financing costs to unaffordable levels in the longer term. Despite such a dangerous borrowing situation, analysts said the euro had rallied on relief Rome was able to sell the bonds at all. Some investors had been concerned about a lack of buyers 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. "But I am still bearish on euro/dollar because I think the euro zone situation is still clearly very serious." The euro rose nearly 1 percent on the day to a session high of $1.3442 after hedge funds initially drove the single currency higher, prompting broad buying. But the single currency relinquished much of its gains after the ECB attracted 194 billion in euros in seven-day bank deposits, falling short of the 203 billion needed to offset its bond purchases. Market participants said the shortfall was the first since May. Investors took this to mean the central bank had effectively initiated a round of quantitative easing as it appeared the central bank had increased the amount of euros in the market, which would cut demand for the currency. But analysts argued that this imbalance must occur on a continued basis to be considered monetary easing. "If we see a chain of shortfalls, or if that shortfall grows, it would be de facto quantitative easing," said Adam Myers, currency strategist at Credit Agricole CIB. "But it's not QE based on this one event." MORE EURO RISKS Investors were wary of holding too many euros before European policymakers are expected to approve details for scaling up the EFSF rescue fund later in the day. Policymakers are also expected to release a vital aid lifeline for Greece. Strategists warned that the euro remained vulnerable to selling unless investors see concrete action, given they have been disappointed by officials in the past. 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. 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. Perceived riskier currencies rallied on higher equities and the Italian auction results. The Australian dollar climbed nearly 2 percent to US$1.0078, before pulling back to US$1.0011 after it was unable to break above technical resistance seen around the 21- and 55-day moving averages around US$1.0096-8. The dollar fell broadly, falling 0.4 percent versus a currency basket, as earlier gains in the euro had dragged most other major currencies higher against the safe-haven U.S. currency. Against the yen, it slipped 0.2 percent to 77.77 yen.

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