(Reuters) - Gold fell 1 percent on Friday after the euro slipped sharply against the dollar, coming under pressure after a euro zone government source said rating agency Standard & Poor's was planning to downgrade several countries in the bloc. Losses were limited as traders awaited confirmation of the rumour, however, and gold remained on track for a second week of gains and its strongest two-week performance in two months. Spot gold was down 1.1 percent at $1,631.24 an ounce at 1517 GMT, while U.S. gold futures for February delivery were down $15.30 an ounce at $1,632.50. Gold's reaction to the spreading euro zone debt crisis has been choppy. Worries over debt helped drive prices to record highs last year even as the dollar strengthened, but in the fourth quarter it traded more in line with other commodities and against the U.S. currency despite jitters persisting. "Gold tends to be supported by mild to strong risk aversion. However, (when) risk aversion rises to very high levels, gold tends to be sold off alongside risky assets," said Anne-Laure Tremblay, analyst at BNP Paribas. "Sovereign issues in the euro zone are clearly not over and we may see further bouts of price correction in the gold market over the coming months," she said. The euro tumbled against the dollar on Friday, coming closer to a 16-month low hit earlier in the week, as fears about an imminent downgrade of euro zone countries had investors betting against the common currency. Standard & Poor's is set to downgrade the credit ratings of several euro zone countries later on Friday, but not those of Germany and the Netherlands, a senior euro zone government source said. Cash gold prices are still up nearly 5 percent so far this year despite a firmer tone to the dollar, as investors bought back into the market after their 10 percent drop in December. Deutsche Bank analyst Michael Lewis said the outlook for gold is good this year. "We have central bank diversification, which we think is a bigger flow story than exchange-traded fund buying. We're also looking for dollar weakness to come back." "We still like the gold story because of negative real interest rates," he added. LUNAR NEW YEAR LOOMS In China, the world's second-largest gold consumer, the Shanghai Gold Exchange said on Friday it will temporarily raise margins and daily trading limits for its gold and silver forward contracts on January 20 ahead of the week-long Lunar New Year holiday. Average turnover, excluding futures, on the SGE in the first fortnight of this month has been 19 percent higher than in the two weeks preceding Chinese New Year in 2011, Rhona O'Connell of metals consultancy Thomson Reuters GFMS said. Gold buying in China is likely to ease off as the Lunar New Year celebrations get underway, however. "We would expect that physical interest will have trailed off significantly out of China by the latter half of next week," said UBS in a note. "Nonetheless it is important to highlight that the market doesn't have the same expectations for Chinese gold imports in the lead-up to the holidays, compared to those seen last year." "And as the most recent Hong Kong trade statistics to China revealed, this market shipped in very impressive volumes before year-end, which probably suggests that there isn't much of a shortage of gold internally to meet local demand." A rise in the rupee to its highest level in five weeks has prompted Indian jewellers to stock up ahead of the upcoming wedding season, meanwhile. Among other precious metals, silver was down 2.1 percent at $29.63 an ounce. Spot platinum was down 1.4 percent at $1,470.74 an ounce, while spot palladium was down 2.2 percent at $622.22 an ounce. Platinum is on track for its best weekly performance since October, however, up 5.2 percent. The metal received a fillip from concerns over South African power supply, which state power utility Eskom said could be under pressure this year.

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