The euro firmed against the dollar on Monday as investors bought into riskier assets, calmed after the release of European banks' stress test results late on Friday.

Just seven of 91 banks failed the tests, including in Spain and Greece, for an overall capital shortfall of 3.5 billion euros.

While some criticism of the credibility of the tests persisted, no new bad news emerged and traders seemed ready to put the event behind them.

German government bonds fell in early trade, with some relief that the stress tests were out of the way, and European shares tracked gains on Wall Street and Asia.

The market assumes that we'll see a positive reaction to the stress tests, and CDS (credit default swap) spreads and such will come down, said Hans Redeker, global head of FX strategy at BNP Paribas.

The dollar will remain weak on the back of a weaker U.S. economic data and on the lack of a credit event. He said the market was being driven more by yield differentials between the United States and Europe, which had narrowed.

By 0710 GMT, the euro rose 0.2 percent from late U.S. trade on Friday to $1.2940. It rose as high as $1.2958 after breaching offers near $1.2950, traders said.

Near term support is seen around $1.2870, its 100-day moving average.

Data from the Commodity Futures Trading Commission showed currency speculators cutting down net short positions in the euro. Net shorts fell to 24,251 contracts in the week to July 20 compared with 27,050 in the prior week. .

EURO GAINS LIMITED?

The euro hit a 10-week high above $1.30 last week, recovering after fears of a euro zone debt crisis and its impact on European banks drove it below $1.19 in early June.

Brighter economic data in the euro zone also bolstered the single currency.

But some said further gains in the euro may be limited.

Friday's stress test results are unlikely to provide any significant support given lingering concerns over a European banking system that is manifestly still reliant on European Central Bank liquidity, UBS analysts said in a note.

Against the yen, the euro hit a seven-week high of 113.49 yen as dealers unwound long yen positions. It was last flat at 113.04 yen.

Better risk tolerance lifted higher-yielding currencies, with the Australian dollar striking a fresh 10-week high of $0.8990. The Aussie now has resistance at $0.9000, with support seen at $0.8895 ahead of $0.8860.

Sterling also hit a three-month high of $1.5502.

The dollar remained under pressure after recent U.S. housing and manufacturing data has suggested recovery may be fizzling. Economists have steadily marked down forecasts for Friday's U.S. second quarter gross domestic product.

The dollar index .DXY fell 0.2 percent at 82.31. The dollar inched up 0.1 percent versus the yen to 87.32 yen.

Tokyo's Nikkei stock average .N225 gained 0.8 percent after the Standard & Poor's 500 Index .SPX rose above 1,100 on Friday as General Electric (GE.N) raised its dividend and Honeywell (HON.N) posted better-than expected results. .T .N

(Additional reporting by Rika Otsuka in Tokyo; Editing by Ruth Pitchford)

BNP Paribas