By Neal Armstrong
LONDON, April 27 (Reuters) - The euro recouped losses on Friday after a smooth Italian bond auction eased concerns over peripheral euro zone debt markets and offset jitters sparked by a downgrade of Spain's sovereign debt and dismal Spanish economic data.
Standard & Poor's cut Spain's credit rating to BBB-plus from A late on Thursday and gave it a negative outlook, warning it expects the government's budget deficit to deteriorate even more than previously thought due to economic contraction.
Spanish data released Friday highlighted the extent of economic weakness in the highly indebted country, with nearly a quarter of the nation's workforce unemployed and retail sales falling for the 21st consecutive month.
The euro initially fell to a session low of $1.3157 in European trade but recovered to a high of $1.3243 after Italy sold 5.95 billion euros of bonds, in an auction which analysts said went well.
"I'm a bit surprised at the euro's resilience but part of the explanation is that the currency channel isn't the cleanest way to express discomfort with the periphery," said Daragh Maher, currency strategist at HSBC.
"If you don't like Spain you sell their bonds and buy German Bunds so the currency impact is muted," he added.
Spanish 10-year bond yields moved back above 6 percent on Friday, while investors sought safety in German bond futures which rose to record highs.
"If you look at the downgrade and economic data out of Spain it makes pretty grim reading," said Jeremy Stretch, Head of European FX Strategy at CIBC Global Markets.
Traders said further weakness in the euro was also being hampered by the extent of short positions already established in the common currency. It was last flat for the day at $1.3218.
The dollar index was steady at 78.921, just above a 3-1/2-week low of 78.823 plumbed on Thursday. Preliminary U.S. GDP data for the first quarter of this year was set for release at 1230 GMT.
The yen was firmer against the dollar and the euro after further easing measures from the Bank of Japan were seen as incremental rather than significant steps to try and dig the Japanese economy out of the doldrums.
The Bank increased bond buying by 10 trillion yen, expanding the target of its bond purchases to bonds with up to three years left to maturity from those with two years or less, and increased its buying of exchange-traded funds (ETFs).
The Bank also extend the period of its asset purchases to June next year from December.
The dollar was down 0.4 percent at 80.64 yen, off overnight highs of 81.45 as Japanese exporters were quick to buy the Japanese currency after hype about the BOJ's easing for weeks.
Market players said the BOJ's easing was no bazooka that would push the dollar beyond its 11-month peak of 84.187 hit last month.
"We are seeing a reappraisal of the effects of QE which I don't think should lead to a weaker yen as a lot of the money will stay in Japan," said Maher at HSBC.
Traders say the dollar has strong support from the cloud top of its weekly Ichimoku charts at 80.42. Another pivotal point will be 80.10, a 50 percent retracement of its rally from February to March.Additional reporting by Hideyuki Sano; Editing by xxx)
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