* Euro falls, erasing earlier gains as Spain worries grow
* Spain's Montoro says financial markets shut to Spain
* Market awaits G7 conference call on euro zone crisis
By Jessica Mortimer
LONDON, June 5 (Reuters) - The euro fell on Tuesday, erasing earlier gains, on growing concerns about whether Spain can restore health to its banks as a minister said high borrowing costs meant Spain was effectively shut out of the bond market.
The comments by Treasury minister Cristobal Montoro highlighted the funding problems facing Spain as investors fretted the country may have to seek external aid.
Analysts said the euro's losses may be limited before an emergency conference call of Group of Seven financial policymakers on the euro zone debt crisis, although the chances of a significant breakthrough looked slim.
The euro fell 0.6 percent on the day against the dollar to hit a session low of $1.2415. It traded more than a cent below an earlier one-week high as investors cut back hefty bets against the currency.
"People will be happy to sell into moves above $1.25," said Anders Soderberg, currency strategist at SEB in Stockholm.
The euro has rebounded from a two-year low of $1.2288 hit on Friday, but Soderberg said its recovery was only "a short-term break in what now seems to be a well-established downtrend".
In addition to the concerns about Spain, investors are worried about the risk that a Greek election in two weeks could push Athens out of the euro.
The depths of the problems facing the euro zone were highlighted by a purchasing managers' survey showing the euro zone's private sector economy shrank in May at the fastest pace in nearly three years.
The common currency faced chart resistance at $1.2545, the 76.4 percent Fibonacci retracement of its decline last week, and at $1.2570, the 23.6 percent retracement of its longer-term decline from a February high near $1.35.
"I don't expect European policymakers to come to an agreement soon. I am ready to sell the euro around $1.2550," said a trader at a Japanese bank in Tokyo.
It also erased earlier gains against the yen and was last down 0.8 percent on the day at 97.08 yen, although this still left it above Friday's 11-year low of 95.59 yen.
Against sterling, the euro was down 0.25 percent at 81.02 pence, off an earlier one-month high of 81.405 pence.
The G7 talks prompted some market players to speculate that the European Central Bank could opt for some form of further monetary stimulus when it meets on Wednesday.
International Monetary Fund Managing Director Christine Lagarde said in an interview with a Swedish newspaper that the ECB had room for another interest rate cut.
There has been some talk of a rate cut, although a recent Reuters poll showed only 11 out of 73 analysts polled expected a move this month.
In a sign of increasing concern about the impact of the euro zone debt crisis, the Reserve Bank of Australia cut interest rates by 25 basis points on Tuesday.
The cut was less than some had expected, however, sending the Australian dollar higher. It was last up 0.1 percent against the U.S. dollar at $0.9733, extending its recovery from an eight-month trough of $0.9581 hit on Friday.
However, some see the Aussie trapped in a downtrend as they expect the RBA to cut rates further in coming months.
Traders will also be looking ahead to testimony by U.S. Federal Reserve Chairman Ben Bernanke on Thursday for any hints that Friday's weak U.S. jobs data could prompt a further bout of quantitative easing.
The dollar was down 0.15 percent against the yen at 78.20 yen, taking it closer to Friday's 3 1/2-month low of 77.652 yen though market players were wary about the possibility of Japanese authorities stepping in to stem the yen's rise. (Additional reporting by Hideyuki Sano in Tokyo, editing by Nigel Stephenson)