Gold held below $1,185 an ounce in Europe on Tuesday, supported by physical demand after this month's slip and a softer dollar, but with a dip in holdings of the largest gold exchange-traded fund undermining sentiment.

Spot gold was bid at $1,184.25 an ounce at 5:40 a.m. ET, against $1,183.75 late in New York on Monday. U.S. gold futures for August delivery firmed 70 cents to $1,183.80.

There seems to be a pause in the gold market, with investors unclear about the immediate trend, said Pradeep Unni, senior analyst at Richcomm Global Services.

Investment demand has taken a back seat and physical buying is only expected to emerge by the end of this month.

There is overall weakness in place and it's likely that gold would be dragged slowly and steadily to $1,170, but weakness beyond $1,165 isn't envisaged, he added.

A decline in holdings of the world's biggest gold ETF, New York's SPDR Gold Trust, suggests the investment demand that drove prices to a record $1,264.90 an ounce earlier in the year is waning, analysts said.

The 0.3-tonne drop in the SPDR's bullion holdings on Monday brought them to their lowest since June 9. The trust has recorded an outflow of 18.7 tonnes of gold so far this month.

Given current market momentum, a net redemption ETF trend could well follow through in August, said UBS analyst Edel Tully in a note. January holds the title of the worst monthly ETF performance in 2010 with 722,200 ounces of net selling action, February follows (with a drop of) 79,600 ounces.

If gold retains its current dynamics, then it's quite possible that investors will return to early first-quarter activity, she added.

EURO FIRM

Elsewhere the euro held near a two-month peak against the dollar as a continued improvement in risk appetite dented interest in the U.S. unit. European shares also rose, adding to gains after closing at a five-week high on Monday. .EU

Earlier in the year, strength in assets seen as higher risk like stocks and the euro tended to coincide with lower gold prices, as the metal was largely being bought by investors seeking refuge from turmoil in other markets.

As the financial markets have calmed in recent weeks, the metal has resumed a more normal trading pattern, moving in line with other commodities and against the dollar, analysts said.

Gold and commodities in general remain a high-beta asset, said Standard Bank analyst Walter de Wet, referring to commodities' high volatility. If risk appetite is high, these things benefit.

Meanwhile India's central bank raised interest rates more strongly than expected, in the face of inflation that has held above 10 percent for the past five months.

While higher interest rates lift the opportunity cost of holding non-interest-bearing gold, higher inflation could boost the metal's appeal as a hedge against rising prices.

It depends how the Indians will see the situation -- whether they will stick to gold as an inflation hedge or prefer to sell gold and put their rupees in a bank, said Commerzbank analyst Eugen Weinberg.

In supply news, African Barrick Gold, the company spun off from the world's biggest gold miner Barrick Gold earlier this year, cut its full-year output guidance to 750-800,000 ounces from 800-850,000 ounces previously.

Among other precious metals silver was flat at $18.14 an ounce, platinum was at $1,550.50 an ounce versus $1,548.25 and palladium at $472.78 versus $471.70.

(Editing by James Jukwey)

New York Gold Inflation