FOREX NEW YORK COMPANIES

Analysts noted, however, that a number of other factors could stem the funding cost increases in coming weeks, at least temporarily.

The U.S. central bank said last week that it will extend the Twist program by another $267 billion, until the end of the year. Twist involves selling short-term notes to fund purchases of long-dated debt, in a bid to lower consumer borrowing costs.

This supply has flooded the short-term rates market and is likely to help to continue to drive up the cost of borrowing overnight funds using short-term Treasuries as collateral.

"The extension of Operation Twist will result in some continued pressure on repo rates on the margin because it's going to mean more competing supply in the front-end," said Brian Smedley, interest rate strategist at Bank of America in New York.

Average overnight rates in the interdealer market have increased to 22.5 basis points in the last month, and analysts see this likely to increase to the mid-20s level. The rate had traded at around 10 basis points last October.

Analysts at Barclays also attribute some of the rise in the rates to new, possibly lower-rated banks adding market share in the market as the Federal Reserve pressures the industry to reduce risks posed by the dominance of three large banks.

Other factors in the coming weeks could stem rate increases, however, even if only temporarily.

Some banks have been using repo to secure extra cash cushions in recent weeks as Greek elections and bank downgrades by Moody's Investors Service threatened new volatility. With these events now over, the banks may reduce these positions.

"In the last month or two it appears that some banks have built up a bit of an excess liquidity buffer leading up to the Greek elections and Moody's downgrades, and that has contributed to some upward pressure on repo rates," Smedley said.

"In the coming weeks we'll see if banks feel more comfortable trimming back that excess liquidity," he added.

Decreasing appetite heading into quarter-end at the end of this week could also reduce pressure in the market, adding to a temporary decline in rates.

Longer term, a deteriorating economy could push repo borrowing rates back down if the Fed launches new quantitative easing to further stimulate growth.

Some economists expect the Fed could launch a third round of easing, focused on purchases of mortgage-backed bonds as soon as its meeting in September.

* Merkel says moves to share debt liability "counter productive"

* Spain's short-term borrowing costs leap at auction

* Yen firm, but political uncertainty in Japan may weigh

By Wanfeng Zhou

NEW YORK, June 26 (Reuters) - The euro fell to two-week lows against the dollar and yen on Tuesday as Spanish bond yields rose and hopes faded that a European summit would make progress in resolving the region's debt crisis.

But further losses ahead of the meeting, which takes place on Thursday and Friday, could be limited as expectations were already low, analysts say. An unexpected positive outcome could spur a short-squeeze in the euro although traders are likely to sell into any bounce.

"The euro is going to trend lower, but I don't think you're going to see any large moves ahead of the summit," said John Doyle, senior strategist at Tempus Consulting in Washington.

"I don't think, realistically, that anyone is expecting a magic bullet to come out of this meeting and to fix all the underlying problems in Europe."

The prospect of a quick move toward a banking union or issuance of common euro zone bonds looked increasingly unlikely, with German Chancellor Angela Merkel describing moves to share debt liability as "counter productive".

Spain's short-term borrowing costs nearly tripled at an auction on Tuesday, a day after the country formally requested a European bank rescue and Moody's cut the ratings of most Spanish lenders. Italy also sold debt, with yields rising to the highest since December.

The euro fell as low as $1.2454, the weakest since June 12, after earlier reported sovereign demand faded. It last traded at $1.2472, down 0.2 percent.

Support was seen near the June 12 low around $1.2441. A break below that level would open the door to a test of the June 1 two-year low of $1.2286.

"There is increasing pessimism as to whether any degree of substantive action will be agreed at the summit. The most encouraging thing is that no one has any expectations, but that's as good as it can get," said Jeremy Stretch, head of currency strategy at CIBC.

"If there is any positive reaction I suspect it will be a case that the devil is in the detail and any rallies will be sold into." He added he expected the euro to drop towards $1.23 over the coming weeks.

The euro zone's debt problems showed no signs of abating, with Cyprus becoming the fifth euro zone country to request help as its banks have been hit hard by exposure to debt-crippled Greece.

Against the yen, the euro slipped 0.5 percent to 99.11 after hitting 98.71, also a two-week low. The euro also dropped against sterling to 79.855 pence, its lowest since the end of May.

UBS said skepticism about the euro was reflected in the bank's latest flow monitor, which showed their clients continued to add to short euro positions last week, while overseas investors offloaded a net $2 billion worth of euro-denominated equities, the most since July 2008.

SHOWDOWN IN TOKYO

The risk of disappointment from another euro zone summit and risk aversion supported the Japanese yen and helped it pull away from a near two-month low against the dollar.

The dollar fell 0.3 percent to 79.47 yen, off a high of 80.59 hit on Reuters data on Monday.

But analysts said the yen could struggle as political uncertainty gripped Japan. Japan's lower house approved a plan to double the sales tax to help curb the nation's snowballing debt, although the vote split the ruling Democratic Party.

"The threat of heightened political uncertainty may weigh upon the yen in the near-term although it is more likely to be offset by ongoing negative developments in Europe which are still fuelling safe haven demand for the yen," Lee Hardman, currency economist at Bank of Tokyo Mitsubishi wrote in a note.

Some market players think the yen may come under pressure if a large number of ruling party lawmakers revolt against Prime Minister Yoshihiko Noda's tax hike plan, which could force him to call an early election.