* Rupee rises 1.2 pct, biggest gain in 2 weeks * Euro rallies; ECB's Draghi signals action to defend euro zone * Rupee outlook still weak; policy reforms key By Subhadip Sircar MUMBAI, July 26 (Reuters) - The Indian rupee rose on Thursday, posting its biggest gain in two weeks after a sharp recovery in the euro and hopes of more monetary easing by the Federal Reserve spurred dollar selling from companies with long positions. Global risk assets rose sharply after European Central Bank President Mario Draghi pledged to do whatever necessary to preserve the euro, including acting to lower high government borrowing costs. The comments sparked big unwinding of long dollar positions from companies and interbank traders, as they looked to cut their losses, according to domestic dealers. However, the near-term outlook for the Indian unit still looks weak as Indian Prime Minister Manmohan Singh is likely to hold off on fuel subsidy and retail reforms because of renewed opposition from party colleagues and coalition allies. Hopes for fiscal reforms and other measures such as opening up the aviation and multi-brand retail sectors had been a major reason behind the rupee's rally from its record low of 57.32 hit in late June. "The time for expectation is over. If the government does not act, the rupee will get hurt," said Ramit Bhasin, head markets-India and South East Asia at RBS. Bhasin added the rupee could rise sharply towards 50 to the dollar if the government acts boldly on diesel reforms by raising prices by 6-9 rupees a litre. The partially convertible rupee closed at 55.52/53 per dollar, as per the SBI closing rate, marking a 1.2 percent gain from its close of 56.16/17 on Wednesday. The rupee rose to as high 55.5150 against the dollar in the session, the strongest since July 20. Month-end dollar demand from oil companies could pressure the rupee in the next several sessions, while traders are also looking forward to the Reserve Bank of India's policy review on Tuesday. A Reuters poll showed 19 out of 20 analysts polled by Reuters expect the RBI to hold rates steady, potentially denting sentiment for the rupee given the negative impact on domestic stocks and the worries it could create about India's faltering economic growth. Still, longer-term, the bearishness that had hit the rupee appeared to be fading. A client survey by RBS showed that market participants expect USD/INR to fall to 54 or below by December, while 58 percent of market participants believe the market is 'neutral' on the cross and 27 percent say the market is short. Three-month offshore non-deliverable forward contracts were trading at 56.54, while the one-month contract was around 55.88. In the currency futures market, the most-traded near-month dollar-rupee contracts on the National Stock Exchange, the MCX-SX and United Stock Exchange all closed at around 55.57, with the total traded volume at around $6.9 billion. (Editing by Rafael Nam)

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