* Euro retreats from two-week high as investors book profit * On track for biggest weekly rise in three-months, $1.30 eyed * Cautious optimism on Greek debt swap talks By Nia Williams LONDON, Jan 20 (Reuters) - The euro retreated from a two-week high against the dollar on Friday as some investors took profits on a short-covering rally but cautious hopes Greece may be nearing a deal to avoid a chaotic debt default looked set to offer support. The single currency was last down 0.3 percent at $1.2920, falling back from a peak of $1.2986 hit in early London trade, but holding well above the 17-month low of $1.2624 reached last week. So far this week the euro has gained more than 2 percent, putting it on track for the biggest weekly rise since October after solid bond auctions in Spain and France on Thursday boosted risk appetite. Analysts said it was normal to see profit-taking after such a strong rally and the euro was likely to stay supported in the short-term as investors await the outcome of the Greek talks. Greece and its private bondholders resume negotiations on Friday amid signs they are inching closer to a deal that will pave the way for a fresh injection of aid before 14.5 billion euros of bond redemptions fall due in March. A positive outcome to the talks could boost the euro, while any negative news could see investors re-establish bearish bets. "This is just profit-taking - we pretty much had a straight-line rally since Monday morning. We could see another 40-odd points on the downside but I think we will hold between $1.2860 to $1.30," said Geoff Kendrick, FX strategist at Nomura. "Because the outcome (of the talks) is so binary, market sentiment tends to go one way or the other. We certainly see it as more risk-on at the moment." Investors stacked up bets against the euro after ratings agency Standard & Poor's downgraded nine euro zone countries including France and Austria last week. Since then sentiment has improved, and some market players said the unwinding of those positions may give the euro a further lift in the near-term, pushing it through reported offers around $1.30, although further gains could be difficult. "This is not only about Greece. We have definitely had a risk-on move and we know there are a lot of euro/dollar shorts in the market. I expect we will breach $1.30 today but run out of steam if the rally goes much higher," said Lutz Karpowitz, currency analyst at Commerzbank. Against the yen, the euro was down 0.3 percent at 99.70, having rebounded since hitting an 11-year low of 97.04 yen on Jan. 16. Aside from the risk of a messy Greek default, market players still see downside risks to the euro in coming months, due to concerns that the euro zone economy may slip into recession and limit progress toward fiscal consolidation in the region. SLUGGISH CHINA MANUFACTURING The euro and the risk-sensitive Australian dollar took in their stride a survey showing China's manufacturers started 2012 in a sluggish mode. The HSBC flash manufacturing purchasing managers index (PMI), the earliest indicator of China's industrial activity, stood at 48.8 in January, below the 50 level that demarcates expansion from contraction. The reading was the highest in three months, however, and was a slight improvement on the 48.7 final figure for the December index. The Australian dollar eased 0.1 percent to $1.0405, hovering near an 11-week high of $1.0450 hit earlier this week. The dollar edged higher versus a basket of currencies to 80.382, moving away from a two-week low of 79.99 hit earlier in the session. Against the yen, the dollar rose 0.1 percent at 77.18 yen , hovering near the top end of the 76.30 yen to 77.342 yen range seen so far in January.

Source