The euro erased early gains against the dollar on Monday as caution set in after initial investor calm in the wake of the release of European banks' stress test results late on Friday.

Early risk-taking sentiment faded, with European shares down 0.4 percent .FTEU3 by mid-morning.

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

Any downside lurch has been prevented by the generally reassuring conclusions of the tests ... no surprises as to the vulnerabilities, and no real headache in terms of the required capitalization to bolster their position, said Daragh Maher, deputy head of FX strategy at Credit Agricole CIB.

At the same time, any relief rally for the euro has been curtailed by inevitable criticism about some of the deficiencies of the stress test assumptions.

By 4:44 a.m. ET, the euro was flat compared with late U.S. trade on Friday at $1.2900, falling from a session high of $1.2958.

He added the euro may make a push toward $1.3125, the 38.2 percent retracement of the December to June move, but a rise to that level would attract reversal plays in the pair.

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

Some said the euro's gains could be restricted by this week's redemption of maturing euro zone bonds and coupon payments worth some 45 billion euros, according to Citi estimates.

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.

Data from the Commodity Futures Trading Commission showed currency speculators cutting 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..

YEN GAINS

The yen gained broadly as investors stepped back from risk-taking.

The euro hit a seven-week high of 113.49 yen as dealers unwound long yen positions, but then ran into offers from Japanese exporters around 113.30/50 yen which took it lower. It was last down 0.3 percent at 112.50 yen.

That helped pull the dollar down 0.3 percent against the yen to 87.16 yen.

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

The dollar will remain weak on the back of weaker U.S. economic data and on the lack of a credit event, said Hans Redeker, global head of FX strategy at BNP Paribas, he said.

The dollar index was flat at 82.50 .DXY.

The Australian dollar came off fresh 10-week high of $0.8990, while sterling also failed to hold a three-month high of $1.5502.

BNP Paribas