(Reuters) - The euro inched up on Friday, taking a breather from two straight days of losses, but gains looked fragile after the European Central Bank dealt it a major setback by not immediately reviving a sovereign bond buying program. Resumption of bond buying in the secondary market would have lowered high borrowing costs for Spain and Italy, which most investors had hoped for. But they were left disappointed by the ECB's lack of action and many said this could drive the euro to recent two-year lows below $1.2050 in coming days. Much though will depend on U.S. non-farm payrolls data due at 1230 GMT. A weak number will increase speculation that the U.S. Federal Reserve may have to ease policy further and hurt the dollar, while a stronger number would give the greenback a lift and drive the euro lower. The euro stood at $1.2195, slightly higher from late U.S. levels a day after it skidded nearly three cents from the day's high to $1.21335 as the ECB indicated any intervention would not come before September - and come only if governments activated the euro zone's bail-out funds to join the ECB in buying bonds. The single currency has erased most of the gains it made after ECB President Mario Draghi raised expectations of a bold and decisive action last week by declaring the bank would do whatever it took within its mandate to preserve the euro. "The euro is headed lower, there is no doubt about that. People are probably waiting for U.S. payrolls and an OK number could see euro fall towards $1.2040," said Geoff Kendrick, currency strategist at Nomura. "The ECB's decision was bad for the euro and it will grind lower. We will see more pain before there is more action." Italian and Spanish 10-year bond yields rose further on Friday highlighting intense pressure on peripheral debt market. In comments throwing some doubts about further ECB action, Draghi indicated that German central bank chief Jens Weidmann had expressed reservations about bond-buying and further efforts would be needed to persuade the Bundesbank before a final vote to take action. "Europe is likely to lurch from one crisis to another for now before things will get better," said Seiya Nakajima, chief economist at Itochu Corp in Tokyo. "The ECB is not legally allowed to monetize debt while buying government bonds at this stage looks like nothing but monetizing. So we'll have to see how they are going to get around the legal problems." These problems along with expectations that the ECB will probably lower interest rates in coming months to support flagging growth will keep the euro pinned near two-year lows. A break below the two-year low of $1.2042 could see it test the 200-month moving average of around $1.2020. Traders cited option barriers at $1.2000 and a drop below that will take the euro to its 2010 low of $1.1876. U.S. PAYROLLS NEXT The recent highs around $1.2390/2406 are likely to become strong resistance for the euro with most speculators and long term investors like reserve managers looking to sell the euro at any bounce. The euro also underperformed against most other currencies, holding barely above a record low against the Australian dollar hit on Thursday, around A$1.1597. Against the yen, it fetched 95.46 yen, not far from a 11-1/2-year low of 94.12 yen hit last month. "There are structural flows out of the euro to other currencies," said a trader at a Japanese bank. But he added lingering hopes that the ECB would eventually step in to buy bonds later this would offer the euro support at lower levels. The dollar was flat against the yen, trading at 78.24, off Thursday's high around 78.54, though wariness about Japan's currency-intervention kept the yen in check. Traders said markets were now bracing for the U.S. jobs data. Analysts polled by Reuters generally expect the economy to have created 100,000 jobs in July and the jobless rate to stay at 8.2 percent. Any upside surprise could temper hopes of more stimulus from the Federal Reserve, which earlier this week signaled it is prepared to act unless the economy stages an unlikely comeback in the next six weeks.

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