* Euro lifts off four-month low vs dollar * Greek politics, Spanish bank problems still weigh on sentiment May 18 (Reuters) - The euro rose from a four-month low against the dollar o n Friday as investors pared bets against the single currency after a 4 percent drop this month, but concerns about Greece and Spain were likely to keep it under pressure. Despite Friday's gains, investors preferred the relative safety of the U.S. dollar and the Japanese yen. They were reluctant to increase risk exposure after Moody's cut the credit ratings of 16 Spanish banks on Th ursday. With no U.S. data to drive foreign exchange markets, investors are most likely to consolidate positions ahead of the weekend following days of euro losses. "The biggest risk today is position squaring into the weekend; however there appears to be increasing evidence that the euro is likely to move lower in the days ahead," said Camilla Sutton, chief currency strategist at Scotia Capital in Toronto. The euro tumbled to $1.2640, not far from its trough of 2012, before recovering to trade 0.2 percent higher at $1.2718. The euro was on track for its third straight week of losses, based on Reuters data. The 14-day exponential relative strength index posted at 15.526, leaving the euro in oversold territory since May 7. The euro fell to 100.17 yen, its lowest since early February, before paring the loss to trade at 100.50, still down 0.2 percent. Strong demand for the greenback helped the dollar index to a four-month high early in the global session but those gains evaporated. Some traders had earlier said the euro's recent decline could slow, given investors may be wary of holding positions over the weekend when leaders of the G8 major industrial economies meet. No economic policy decisions are expected from the G8 but officials said U.S. President Barack Obama hoped to promote discussion on steps to resolve the euro zone crisis. "The U.S. dollar is struggling to hold its ground ahead of the G8 Summit as hopes surrounding the meeting prop up market sentiment, but the rise in risk-taking behavior is likely to be short-lived as we don't expect to see any major developments over the weekend," said David Song, currency analyst at DailyFX. " Although the U.S. dollar remains overbought, the headline-driven market continues to increase the appeal of the greenback as the turmoil in Europe intensifies." Strategists said the euro would remain vulnerable to further bad news out of the euro zone, and looked set to test the 2012 trough. A break below there would take the euro to its weakest level versus the dollar since August 2010. SPAIN "If it's not Greece, it's Spain that we talk about to sell the euro. People are looking for bad news and they are concerned there appears to be no solution," said Lutz Karpowitz, currency analyst at Commerzbank in London. Greece faces fresh elections on June 17, with many investors increasingly concerned a victory for anti-bailout parties could lead to Greece exiting the euro zone. A recent poll showed Greece's conservatives have overtaken the anti-bailout leftist SYRIZA in popularity, although the volatile political mood meant most analysts saw the outcome of the elections as a significant risk. Worries about Spain's banks and prospects of more state bailouts for lenders kept the country's borrowing costs high. Talk of a ban on naked short-selling of Spanish banking stocks lifted Europe's bank shares. This brought some relief for the euro, but the common currency's medium-term prospects remained bearish. Reflecting that, one-month euro/dollar implied volatility climbed to around 11.55 percent while three-month risk reversals - a measure of relative demand for bets on the euro rising or falling - were at -3.5 vols on trading platform GFI in favour of more euro weakness. The dollar was down 0.3 percent against the yen at 79.07 yen after going to a three-month low of 79.01, according to Reuters data. Traders cited stop losses orders below 79.00 yen and 78.80 yen, while offers were likely to cap dollar gains around 79.50.

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