* Euro rallies from 4-year low against the dollar * ECB's Nowotny says euro in normal range * Investors worry austerity plans will weaken growth (Recasts, updates prices, adds detail; changes dateline, previous LONDON and byline)

By Nick Olivari

NEW YORK, May 17 (Reuters) - The euro rallied against the dollar on Monday on a rise in risk appetite after a U.S. report showed strong demand for U.S. long-term securities and a flurry of short covering by investors who had bet the currency would fall further.

Earlier the euro fell to a four-year low against the dollar on persistent concerns with euro zone sovereign debt and fears that planned austerity measures will hurt growth in the region, but its fortunes revived amid German bank euro buying.

A short cover is buying a security on which the bet had been for further declines to prevent losses when it unexpectedly rallies.

A Treasury Department report showing foreign investors set a record for purchases of long-term U.S. securities in March, snapping up $140.5 billion and shattering a previous peak seen in 2007 [ID:nN17253180], added to the decline in risk aversion.

The euro rose after TICs data injected a little bit of risk appetite, said Kathy Lien, director of currency research at GFT in New York. Short euro trading is over crowded and if there is a reason for traders to adjust positions they do it.

In early morning New York trade, the euro EUR= was around $1.2405 against the dollar, up 0.4 percent on the day. Traders said stops were hit as the euro moved back above $1.2330.

The euro has fallen more than 7 percent against the dollar this month, and is about 14 percent lower for the year, making it the worst-performing major currency.

But ECB policymaker Ewald Nowotny said the fall in the currency was not a cause for concern, adding the exchange rate was in a normal range and there was no reason for hysteria about it. [ID:nDEK002037]

Technical analysts said the next key support was at $1.2135, the 50 percent retracement of the rally from the all-time lows near $0.82 to the record highs just above $1.60.

Analysts said the widening euro zone problems had prompted a money market dollar liquidity shortage.

If the sharp deterioration in money markets persists into this week, look for central bank action to lower the cost of access to their dollar funding facilities, Citibank analysts said in a note.

The euro had extended its losses in Asia after falling below the post-Lehman October 2008 low around $1.2330, where traders said stop-losses from model accounts were lurking, and fell as far as $1.2234 on trading platform EBS, its lowest since April 2006.

A 750 billion euro rescue package from the European Union and the International Monetary Fund aimed at shoring up euro zone bond markets has done little to underpin the euro.

On Friday, the single currency euro plunged after European Central Bank policymaker Axel Weber said it was important not to underestimate lingering dangers to financial stability. [ID:nLAG006286].

German Chancellor Angela Merkel on Sunday said the rescue plan had only bought time to sort out the yawning gap between the euro zone's strongest and weakest economies. [ID:nLDE64F0FQ].

Traders say the austerity measures announced by Greece, Spain and Portugal could hurt growth in the near term and force the European Central Bank to keep interest rates low.

There is a rapidly growing consensus that (the euro) could fall to parity with the dollar, said Ed Yardeni, president & chief investment strategist at Yardeni Research.

Data released on Friday showed speculative bets against the euro hit a record high in the week to May 11. [ID:nN14193796].

Against the yen, the euro traded up 0.3 percent at 114.75 yen after falling to 112.47 EURJPY= in Asia trade.

Sterling slid to its lowest since March 2009 at $1.4249 before rising back to $1.4501, still down 0.3 percent on the day. The pound was hit by data showing the past year's rise in British house prices may be cooling. [ID:nLDE64C1G4]

The dollar briefly fell further against the yen, though well off the session low, after a gauge of manufacturing in New York State continued to grow in May but at a slower pace. [ID:nN17209874]. The dollar was last at 92.51 yen, up 0.1 percent from Friday's close.

Weakness in the euro and the pound helped the dollar index .DXY, a calculated measure of the dollar's performance against a basket of currencies including the Swedish Crown, to rise above 87.00, the highest since March 2009. It later eased to 86.051, the session low.

(Additional reporting by Neal Armstrong in London) (Reporting by Nick Olivari; Editing by Theodore d'Afflisio)

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