* Euro rises on optimism over Greece aid deal
* Yen edges up from 7-month lows vs dollar and euro
* German IFO awaited, could weigh on euro
By Anirban Nag
LONDON, Nov 23 (Reuters) - The euro rose to a three-week high against the dollar on Friday, heading for its second week of gains on optimism that Greece's lenders were nearing an agreement that will release aid.
The single currency extended gains after an influential German business sentiment confounded expectations to show a rise in November. The Ifo business climate index, a barometer of economic health in Europe's largest economy, rose to 101.4 from 100.0 last month and beating forecasts of a drop to 99.5.
But the medium term economic outlook for the region remains bleak, keeping alive risks of further policy easing by the European Central Bank which weigh on the euro.
"The market is getting a bit confident that a Greek deal will be struck. This will remove one of the near-term uncertainties in the euro zone and some of the short euro bets will be squeezed as a result. But I do not see the euro rising much beyond $1.30," RBS currency strategist Paul Robson said.
"While the short-term risks stemming from Greece wane, the medium-term risks in the euro zone from weaker growth and missed debt targets remain and that will see the euro struggle."
The euro hit a fresh three-week high of 1.2913 from $1.2880 before the German IFO survey was released and breaking through resistance level of $1.2910, its 55-day moving average.
"The IFO was a bit of surprise, but these are levels which we saw back in October and not really a turn in sentiment," Stuart Frost, fund manager at RWC Partners. "We expect the euro's gains to fizzle out."
Traders reported steady selling of euros by Asian central banks at higher levels with stop-loss buy orders for euros cited at $1.2920.
The euro has gained nearly 1.5 percent against the dollar in the past two weeks as yields on Greek bonds fell on expectations that euro zone ministers should be able to sign off on another tranche of aid for Greece on Monday.
There were signs on Friday that lenders were inching toward a compromise on the key issue of how to cut Greece's debt pile further than previous estimates.
The single currency, however, slipped from a seven-month high against the yen on steady selling by a large U.S. bank. It eased to 106.10 yen, down 0.1 percent on the day, and off its peak of 106.585 struck on Thursday.
That was some respite for the yen from steep losses in the past two weeks due to expectations of more aggressive monetary easing in Japan. The dollar also eased 0.2 percent to 82.25 yen , pulling away from Thursday's high of 82.84 yen, its strongest level since early April.
YEN CARRY TRADES?
The dollar has climbed 3.4 percent against the yen in the last two weeks, with the yen weakened by expectations that a likely new Japanese government after an election scheduled for December would push the Bank of Japan to implement more drastic monetary stimulus.
Shinzo Abe, the leader of Japan's opposition Liberal Democratic Party, which is tipped to win the election, has called for measures such as having the BOJ buy bonds issued specifically to fund public works projects and pushing short-term interest rates below zero.
His party's policy platform calls for a 2 percent inflation target, and seeks to ensure that the BOJ will pursue it vigorously with a possible revision to legislation that guarantees the central bank's independence.
In an interview with the Wall Street Journal published on Friday, Abe was also quoted as saying that he would consider postponing sales tax increases agreed in August if the economy remained mired in deflation.
Analysts said loose monetary measures along with lax fiscal policies could keep the yen under pressure and could see yen-funded carry trades return. Under these trades, investors sell the low-interest rate yen to buy more higher-yielding assets.
"Speculation is already growing that the yen will be the funding currency of choice for 2013 carry trades - a view we tend to support," Chris Turner, head of FX strategy at ING, said in a note.
"Expect dollar/yen corrections to prove reasonably shallow, before we see a test of 83.20."