* Euro falls against dollar and yen after German ZEW
* Dollar index hovers near 5-week high
* Yen selling curbed by sharp rise in Japan bond yields
By Anirban Nag
LONDON, May 14 (Reuters) - The euro fell on Tuesday after German investor morale pointed to a tepid recovery in Europe's largest economy and offset a bigger-than-expected rise in industrial output in the euro zone.
The euro drew some support from signs of a robust response to a Spanish syndicated debt sale, but with the broader euro zone still grappling with a recession and risks that the European Central Bank could slash its deposit rate - the level at which banks park surplus funds with it - to negative, investors were cautious about the single currency.
The euro gave up earlier gains and was down 0.15 percent against the dollar at $1.2955, well below a session high of $1.3030 and not far from a five-week low of $1.2935 with model funds cited as sellers.
It was down 0.4 percent at 131.765 yen.
"We saw a bit of a squeeze in the euro that took it higher, but it has petered out," said George Saravelos, currency strategist at Deutsche Bank. "The talk of negative rates is putting a ceiling on the euro and while a cut is not our baseline scenario, there is a risk of it happening."
The ZEW think tank said its monthly poll of economic sentiment rose to 36.4 points from 36.3 in April. It fell short of expectations for a reading of 38.3.
Data also showed output at euro zone factories rose much more strongly than expected in March, but the overall picture remained mixed as industrial output in France and Italy, the bloc's second and third largest economies, decreased.
ECB policymakers have been flagging the prospects of further monetary easing, including a cut in the deposit rate currently at zero, if economic activity deteriorated. This would mean depositors would be charged for leaving funds there, hence keeping the currency under pressure, traders said.
DOLLAR INDEX RECOVERS
The euro's fall saw the dollar index, which tracks the U.S. currency's performance against a basket of major currencies, cut losses. It was up on the day at 83.36, not far from a five-week high of 83.438 struck on Friday.
The dollar also pared most of its losses against the yen, and was last trading down 0.1 percent on the day at 101.70 yen . It was not far from a 4 1/2-year high of 102.15 yen set on Monday.
Traders said the yen-selling spree was on pause due to a spike in Japanese government bond yields, which reduces the relative attraction of foreign bonds for Japanese investors.
But the dollar was underpinned by data showing U.S. retail sales unexpectedly rose in April. It could gain further if upcoming U.S. economic data pointed to a recovery.
"We think against the yen the dollar can go higher, helped by rising U.S. yields," said Marcus Hettinger, FX strategist at Credit Suisse.
There is a raft of U.S. data this week including Wednesday's industrial production, housing starts and consumer prices on Thursday and consumer sentiment data on Friday.
The rise in core retail sales, in the wake of strong job growth in the last three months, strengthened the view the U.S. Fed could scale back its asset-buying programme later this year.
(Editing by Hugh Lawson and Chris Pizzey, London MPG Desk, +44 (0)207 542-4441)