The euro rose on Thursday as strong demand at a Spanish debt auction eased concerns about how the country will fund its large debt, but caution before a European Central Bank policy decision capped gains.

Peripheral euro zone government bond yield spreads over German benchmarks narrowed after the auction of new three-year bonds. Widening spreads in recent days have weighed on the single currency.

But traders said market players were wary of taking on long euro positions ahead of the ECB decision, with option expiries at $1.20 and $1.21 later in the day also helping to confine the single currency within a $1.20-$1.21 range.

Technical analysts said the euro's downward trend would remain intact barring a move above $1.2135, the 50 percent retracement of the 2000-2008 euro rally.

The ECB is expected to hold rates at 1.00 percent. It could offer extra funds to banks to ease strains from the euro zone debt crisis, and bank chief Jean-Claude Trichet will be pressed for details of its bond-buying programme.

The ECB decision is all about event risk, said Gavin Friend, currency strategist at nabCapital. It is difficult to see anything positive coming out of it, although the mood is likely to be set by the broader market backdrop.

The Spanish auction has cemented euro support a little. It adds to the story that the euro may be due a bit of a bounce as it has come a long way down in a relatively short space of time, he said.

At 1005 GMT, the euro was up 0.6 percent against the dollar EUR= at $1.2052, above Monday's four-year low of $1.1876. Traders said investors were tending to sell on rallies towards $1.21, but a break above $1.21 could see the euro extend gains.

Severe debt problems in a number of euro zone countries, coupled with concerns about the future of the euro have caused the currency to fall around 16 percent against the dollar since the start of the year.

Against the yen, the euro rose 0.1 percent to 109.50 yen EURJPY=R. The dollar was down 0.2 percent at 91.04 yen JPY=, staying above its 200-day moving average at 90.90 yen.

ECB AWAITED

The ECB's decision is scheduled for 1145 GMT, with Trichet's accompanying news conference at 1230 GMT.

If they continue to buy bonds that may be seen as positive, but on the other hand they haven't succeeded so far in stabilising yields, said Antje Praefcke, currency strategist at Commerzbank in Frankfurt.

The Bank of England announces its policy decision at 1100 GMT with no change to interest rates expected.

Earlier, Dai Xianglong, chairman of $114 billion China's National Social Security Fund, said the euro would gradually stabilise and the U.S. fiscal deficit remained a big concern, which helped lift the euro back above $1.20.

The comments came as a relief as some in the market have said the euro zone debt crisis could prompt central banks, including China's, to cut their euro reserves.

The euro was also helped by China confirming exports jumped 48.5 percent in May from a year earlier, which buoyed shares and riskier currencies.

The Australian dollar rose 1.7 percent against the U.S. dollar AUD=D4, buoyed by strong Australian jobs data, while a rate rise in New Zealand dollar lifted the Kiwi 1.6 percent versus the U.S. dollar NZD=D4.

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