* Euro off lows, but upside seen limited
* Further slowdown in euro zone inflation seals case for ECB action
* Aussie firmer vs USD ahead of GDP data due 0130 GMT
By Ian Chua
SYDNEY, June 4 (Reuters) - The euro clung onto modest overnight gains early on Wednesday, having been squeezed higher in what some traders described as a 'buy-the-rumour-sell-the-fact' move in the wake of subdued euro zone inflation data.
The common currency last stood at $1.3620 after climbing off a four-month trough to $1.3585. It also gained ground on the yen, reaching a three-week high of 139.78.
The bounce in the euro knocked the dollar index off a 3-1/2 month peak set on Monday. It was last at 80.573, down from the high of 80.681.
Figures on Tuesday showed euro zone inflation slowed further in May, all but sealing the case for the European Central Bank to carry out its promise to act when it meets on Thursday.
Markets were already poised for a downside surprise following soft German inflation numbers on Monday, so the result instead prompted some investors to cover bearish euro positions and take profits in bunds. Benchmark German yields rose to a one-week high of 1.42 percent.
Sources at the ECB told Reuters last month the bank was preparing a package of policy options, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms.
"We continue to forecast a small 10 basis point rate cut to all key rates, including therefore a negative deposit rate for the first time," analysts at Nomura wrote in a note to clients.
"We also expect the ECB to announce a credit easing programme in the form of a targeted LTRO funding scheme to help address high interest rates charged on periphery corporate loans and provide an insurance mechanism against the risk of credit crunch."
While the ECB is contemplating new measures to shore up growth in the euro zone, latest data showed the U.S. economy is motoring along after a weather-induced slowdown early in the year.
Figures on Tuesday showed new orders for U.S.-made factory goods rose for a third straight month in April and automakers reported robust vehicle sales in May, boosting the second quarter outlook.
Benchmark U.S. yields rose to three-week highs, extending a reversal from 11-month lows plumbed last week. That in turn helped the dollar reach a one-month high against the yen at 102.56.
The greenback, however, underperformed its Australian counterpart as Aussie bears stayed on the sidelines ahead of local data that could show the economy grew at its fastest clip in two years in the first quarter.
The Aussie was last at $0.9264, having climbed off a low of $0.9229 on Tuesday.
Australia's gross domestic product (GDP) is expected to rise a solid 1.0 percent in the quarter, the biggest quarterly gain since the first quarter of 2012.
The market is already positioned for a solid result, so any disappointment will likely see the Aussie beat a hasty retreat.
Even with a healthy headline number, analysts at National Australia Bank said the economic performance is still mixed with dwelling investment quite strong, consumption solid, while business investment and government spending will be close to flat. (Editing by Shri Navaratnam)