4:09am EDT
* Euro gets a respite, still on track for weekly losses
* EUR option barriers at $1.2500; stops at $1.2480
* USD/JPY supported by importers, short-covering
By Anirban Nag
LONDON, May 25 (Reuters) - The euro inched up from two-year lows against the dollar on Friday as bearish investors took a breather from a sharp sell-off this week, but worries about a possible Greek exit from the euro zone and risk of contagion would make gains fleeting.
The euro traded 0.3 percent higher on the day at $1.2575 , pulling away from $1.25155, its lowest level since July 2010 plumbed the day before. Traders cited a reported option barrier at $1.2500 that could check losses with offers around $1.2600 and stop-loss orders above $1.2620.
Despite the bounce, the common currency has lost more than 5 percent against the dollar so far this month and is on track for its fourth straight week of losses.
Those losses came as macro funds, real money and institutional investors ramped up selling of the currency, as concerns about Greece leaving the euro zone rose after an inconclusive election left the country at risk of bankruptcy and a possible exit from the currency bloc.
Greeks are voting again on June 17, with polls showing a close race between parties supporting and opposing terms of the country's international bailout, keeping markets on tenterhooks.
"The euro is a bit higher today, but I will be surprised if it takes stops above $1.2620. The medium-term prospects are not good," said Geoff Kendrick, currency analyst at Nomura.
"We think if Greece does not exit the euro zone, the euro will see a gradual decline to $1.23 in coming months. But if it does, then we see the euro falling to $1.20 by the end of the second quarter and $1.15 by the end the third."
Investors are just not rattled by the fallout of a Greek exit. They are also concerned about the health of the Spanish banking sector, chances of a deep and damaging slowdown in the euro area and the lack of any aggressive policy measures to address the escalating debt crisis.
Spanish lender Bankia, which was part nationalised this month, was set to ask the government for more than 15 billion (US$19 billion) on Friday to bail it out.
All of which has seen the euro being sold off on rallies with many analysts and traders now expecting it to drop below $1.25 and $1.20 to its 2010 trough of around $1.1875 in the coming weeks.
"If the euro didn't have enough to contend with as Greek exit speculation persists, the economic data points to a clear worsening in economic conditions," said Derek Halpenny, European Head of global markets research at Bank of Tokyo Mitsubishi.
"The ECB will soon have to act again to ease its monetary stance by probably cutting the refinancing rate and this can only reinforce euro downside pressures."
DARKENING PICTURE
European Central Bank data showed 35.4 billion euros of net direct portfolio investment flowed out of the euro zone in March, as investors shunned the region's assets.
Investor skittishness is well-reflected in the options market, where euro/dollar one-month at-the-money implied volatility spiked to 13.13 percent, its highest in more than four months.
With the euro on the backfoot, the dollar has been the big winner with its index against a basket of major currencies edging up to 82.411, its highest since September 2010.
Against the yen, the greenback was 0.1 percent higher at 79.65 yen, supported by Tokyo importers and short-covering ahead of the long weekend in the United States. Sell offers around 80.00 yen are poised to cap any further gains, traders say.
The euro was flat against the Swiss franc at 1.2015 francs, having jumped to 1.20769 francs on Thursday, its highest since mid-March on market talk the Swiss government is going to impose a tax on deposits and chatter that the Swiss central bank initiated a short squeeze in the pair.
Traders say the Swiss National Bank has been buying euros in the past few weeks to protect the floor at $1.20 francs, but some investors are still piling on bets through the options market that the peg will be breached in coming days if the euro zone crisis escalates.
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