(REUTERS) - The euro grabbed support from strong investor demand at an Italian debt sale on Wednesday but the currency's gains against the dollar were limited in thin trade pending an auction of longer-dated bonds.

Market players said Italy's auction on Thursday of 8.5 billion euros of debt with maturities of up to 10 years would provide a better gauge of pressure on the heavily-indebted euro zone sovereign than Wednesday's sale of 6-month bills.

Italy will need strong demand on Thursday from international investors to hold benchmark 10-year borrowing costs below the critical 7 percent level that is seen as unsustainable in the longer term.

While Wednesday's auction attracted solid demand from domestic banks, analysts said the euro might test an 11-month low if investors proved reluctant to take on long-term exposure to Rome.

The euro edged up to a session high of $1.3080 after the six-month BOT bills were sold at half their yield levels compared with a similar sale last month.

The shared currency later pulled back to $1.3071, little changed on the day, hovering near $1.2945 hit earlier in the month, its weakest since January.

Euro offers were cited above $1.3080 capping further gains, while immediate support was seen around $1.3050, a trendline drawn from the Dec. 14 trough.

Traders said volumes were very low as many market participants were absent due to the year-end holiday season, and investors were nervous that thin liquidity could exacerbate choppy moves.

The euro has gone up a little bit but it would have been a brave decision to take a position one way or another, said Neil Mellor, currency strategist at Bank of New York Mellon.

Tomorrow's auction is more important and will give more insight into general sentiment. Today was a warm-up.

Funding pressures on indebted euro zone sovereigns look set to intensify in early 2012. Some 230 billion euros of bank bonds, up to 300 billion euros in government bonds, and more than 200 billion euros in collateralised debt are all maturing in the first quarter of next year.

Analysts said there appeared to be reluctance among European banks to lend to each other or invest in euro zone sovereign debt, despite a recent massive liquidity injection by the European Central Bank through a three-year long-term refinancing operation.

Latest figures showed banks have deposited 452 billion euros ($591 billion) at the central bank. Emergency overnight borrowing also remained high at above 6 billion euros.

Some strategists said the figures suggested banks would not be keen to use the funds to buy Italian debt, as some policymakers have urged, and help pull borrowing costs lower.

The bond auction seems to be the biggest event this week and it's also a theme that will probably dominate the market in the first quarter of next year, said Niels Christensen, FX strategist at Nordea.

Euro/dollar still looks heavy and the risks are definitely more to the downside. We know markets are quite thin, that leaves the possibility of a large move if the market is hit by some surprising news - bad or good.

U.S. CRITICISM

With trade in the euro quiet, the dollar index was unchanged at 79.756, not far off the 11-month peak of 80.730 hit on Dec. 14.

Against the yen, the greenback stood at 77.69, remaining in a well-trodden range roughly between 77.00 and 78.20 seen so far this month.

The U.S. Treasury, in a semi-annual report on Tuesday, criticised Tokyo for its solo yen-selling interventions in August and October that followed joint G7 action in the aftermath of the March 11 earthquake.

But a Japanese government official said Japan would not change its stance of taking appropriate action in the foreign exchange market as needed. Japan has intervened at least three times this year, spending a record sum to battle the yen's surge as other currencies slipped on euro zone debt woes and a stuttering global economy.

Rob Ryan, strategist at BNP Paribas in Singapore, said the impact of the U.S. Treasury report would be limited given uncertainty about the Japanese economy's outlook.

I think if they (Japanese authorities) feel they have to intervene, they will intervene, Ryan said, adding that a dollar drop to the low 76s might be enough to prompt further action from Japan.