The euro fell on Tuesday, reversing a climb to its highest against the dollar in more than two month, as European shares fell and investors reckoned its gains have been overdone before bank stress test results.

The euro retreated from $1.3029 hit on trading platform EBS as some investors questioned whether the single currency would sustain gains above $1.30 given that stress test results due on Friday may show weakness in euro zone financial institutions.

Poor demand at a Hungarian Treasury bill offer also stung the euro as it weighed on risk sentiment. In turn, the dollar was boosted across the board, recovering from Monday's fall against a currency basket on weak U.S. economic data.

We've seen risk appetite claw back a fair amount, and the market is questioning whether that move is valid, said Jane Foley, director of research at Forex.com.

There is a lot of better news priced into the euro, and ahead of the stress tests, it's probably gone a little too far. The market is taking some risk off the table.

By 1108 GMT, the euro EUR= traded 0.3 percent lower on the day at a session trough of $1.2903 as European shares .FTEU3 fell 0.5 percent. Traders saw support for the euro around the previous day's low of $1.2870.

Some in the market said the euro's losses accelerated after Hungary sold a smaller amount of three-month Treasury bills than originally planned.

This contrasted with auctions by Spain and Greece, which sold short-dated paper without incident, while Ireland managed to sell six- and 10-year debt -- albeit at higher yields -- a day after Moody's downgraded its sovereign rating.

YEN NEAR 7-MTH HIGH VS DOLLAR

The dollar rose 0.1 percent to 86.83 yen JPY=, but stayed near a seven-month low of 86.27 hit on EBS on Friday. Yen strength has prompted market investors to consider how Japanese authorities may deal with a firmer currency.

Traders suspect they may not want to see the 85 yen level breached in a hurry, though many doubt Tokyo is ready to intervene at this point.

The dollar was down 0.1 percent against the Canadian dollar at C$1.0533. Markets expect the Bank of Canada to raise interest rates by 25 basis points on Tuesday.

The euro's winning streak paused after the single currency had capitalised on a run of weak U.S. data, the latest of which was a slide in July home builder confidence released on Monday.

Some in the market say results of European Union bank stress tests due out on Friday are expected to soothe market concerns about the region's banking system, but others speculate some banks will not pass the test.

Nationalised German lender Hypo Real Estate is expected to fail the test, a source familiar with the matter said on Monday.

Some analysts said that even if some banks failed the test, overall, the results would be positive for the euro on the view that signs of weakness would demonstrate the test's validity.

That would mean the test scenarios are working. If all of the banks passed, the market would say the tests were unrealistic, said Lutz Karpowitz, currency strategist at Commerzbank in Frankfurt.

But some analysts say the euro could be in for a buy on the rumour sell on the fact retreat after the stress test results, having risen nearly 10 percent from a four-year low against the dollar since June 7.

The market also awaited U.S. housing starts data for June after data on Monday showed the NAHB/Wells Fargo Housing Market index fell more than expected in July to its lowest level since April 2009.

(Additional reporting by Tamawa Desai, editing by Nigel Stephenson)

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