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* Euro still smarting from 'Cyprus model' suspicions
* Little sign of contagion to Italy, Spain
* Yen under pressure ahead of April 3-4 BOJ meeting
* Commodity currencies shine on rising risk appetite
By Sophie Knight and Hideyuki Sano
TOKYO, March 27 (Reuters) - The euro hovered near a four-month low against the dollar on Wednesday after a rescue deal for Cyprus raised fears about financial stability in the currency bloc, while the yen slipped on hopes of more bond buying by the Bank of Japan.
Commodity currencies held firm after upbeat data on U.S. home prices helped to lift U.S. shares, with the Dow Jones Industrial Average hitting yet another new record and the S&P 500 near its all-time closing high.
The euro dropped 0.1 percent to $1.2852 on Wednesday, not far from the four-month low of $1.2828 hit on Tuesday. Against a resurgent Australian dollar, it traded near the four-month low of A$1.2225 hit on Tuesday, fetching A$1.2276 .
The common currency is still suffering from suspicions, following the Cyprus bailout, that bank depositors and bond holders may be forced to foot the bill in future rescue deals in the currency bloc.
Jeroen Dijsselbloem, head of the Eurogroup of finance ministers, raised the idea on Monday, saying that the rescue plan for Cyprus will serve as a model for resolving future euro -zone banking crises. He later appeared to backtrack, saying Cyprus was a unique case, but the damage was already done.
"The euro still has downside risks. You never know what's coming up next," said a trader at a European bank.
"But some hedge funds are now covering short positions in the euro and I think the currency may stabilise for now," he also said.
Some analysts say the euro could steady in time for the Easter holidays this weekend, particularly as there is so far little sign of dreaded contagion to the euro zone's larger economies, such as Spain and Italy.
Their debt yields were well within recent ranges, thanks in part to the European Central Bank's bond buying programme.
However, other analysts said alarm bells could ring if the two-year German bond yields, currently at 0.005, go negative.
"The euro would likely come under heavy selling pressure if the yield were to drop below zero, as it didn't even go negative in the aftermath of the Greek election last year," said Minori Uchida, senior analyst at Bank of Tokyo-Mitsubishi UFJ.
"If it stays positive, there will be little other downside pressure on the euro for the moment," he said.
The yield on the two-year German bonds last dipped into negative territory in December, after doing so for the first time in July as Spanish and Italian borrowing costs hit crisis levels.
The euro gained about 0.3 percent against the yen to 121.80 yen on Wednesday, as the Japanese currency fell on reinforced expectations of major stimulus from the Bank of Japan after the Nikkei business daily said the central bank will boost bond buying at its policy review meeting on April 3-4.
The news nudged the dollar up 0.4 percent to 94.78 yen , extending its rebound from a one-week low of 93.53 yen on Monday.
Commodity currencies also held firm on improved risk sentiment after U.S. home prices posted their biggest year-on-year gain in six and a half years in January. This sign that wounds inflicted by the 2008 financial crisis are healing helped boost Wall Street shares.
The Aussie lost 0.1 percent to $1.0465, with the Reserve Bank of Australia's reassurance that the country's banks are robust and prepared to meet new strict liquidity controls putting prospects of a rate cut even further out of reach.
Helped by a stellar jobs report on March 14, the Aussie had rallied 3.8 percent from a 7-1/2 month low on March 4 to a high of $1.0497 on Tuesday.
While the currency added 4.5 percent in the same period against the broadly weakening yen, analysts said it will take equally strong data in April to push the Aussie over strong resistance at 100 yen. On Wednesday. it fetched 99.11 yen.
The Canadian dollar was firm after gaining 0.5 percent on Tuesday to trade at C$1.0164 per U.S. unit, near one-month high of C$1.0160 hit on Tuesday.