* Euro rises 0.4 pct at $1.2708 <EUR=>
* Talk of euro option barriers at $1.25 and $1.31
* Stg steadies as new UK govt starts; BoE report eyed
* Little impetus from modest euro zone Q1 growth
(Adds quotes, updates prices)
By Tamawa Desai
LONDON, May 12 (Reuters) - The euro reversed early losses to edge higher on Wednesday as euro zone peripheral government bond yields dropped, partly easing debt concerns as data showed the single currency zone grew only modestly in the first quarter.
Spain announced public spending cuts to rein in its budget deficit [ID:nLDE64B0MM] and as European central banks were seen buying Portuguese, Irish and Greek government bonds. [ID:nMAT012339]
But the euro's rebound remained below the near $1.31 level seen shortly after a $1 trillion emergency aid package was announced on Monday to stave off a euro zone debt crisis.
By 1002 GMT, the euro rose 0.4 percent to $1.2708 <EUR=>, after hitting a session high of $1.2739. Traders said stop-loss buys were triggered above $1.2720, accelerating the gains, with hedge funds buying back euros. Offers were seen around $1.2740.
Earlier data which showed higher-than-expected growth in Germany and Italy [ID:nLDE64B0BD] [ID:nLDE64B0ZL] helped to trigger a short squeeze in the single currency. Latest data from Commodity Futures Trading showed currency speculators had boosted net euro short positions to a euro lifetime high in the week ended May 4. [IMM/FX]
Traders also cited talk of a double no-touch option position in the euro with barriers at $1.25 and $1.31. Such a position suggests that the holder would buy euros on any drop towards $1.25 to defend that position until it expires.
Some expect the bounce to be short-lived.
"The data may provide some support, but the bigger picture for the euro is still negative," said Ian Stannard, senior currency strategist at BNP Paribas.
EURO ZONE GROWTH MODEST
Euro zone gross domestic product growth came in as expected at 0.2 percent for the first quarter. [ID:nLDE64A127]
Against the yen, the euro was up 0.6 percent at 118.02 yen <EURJPY=R>.
European Central Bank President Jean-Claude Trichet reiterated on Wednesday the central bank's stance to sterilise, or drain excess liquidity from its government bond buying.
"All liquidity which is being put in through these interventions will be taken back. We are not running money printing presses," he said on French radio.
The dollar rose 0.2 percent at 92.89 yen <JPY=>.
Some also remained wary after the Wall Street Journal reported U.S. federal investigators are probing whether Morgan Stanley <MS.N> misled investors about mortgage-derivative products it helped design and sometimes bet against. [ID:nSGE64B05F]
Sterling was tracking the euro's rally, trading up around 0.4 percent versus the dollar at $1.5018 after rising to a session high of $1.5036. Against the euro, the pound was broadly unchanged at 84.65 pence.
UK Conservative Party leader David Cameron became Britain's new prime minister on Tuesday after securing a power-sharing agreement between his centre-right party and the smaller Liberal Democrats.
They plan to stick to the Conservatives' line of taking immediate steps to reduce the budget deficit, seen rising to more than 11 percent of GDP this year, by cutting 6 billion pounds in non-frontline services this year. But there was uncertainty in the market about the new government's overall deficit reduction plans.
(Editing by Susan Fenton, John Stonestreet)