* Monti says he will quit once Italy's budget is passed * Italian turmoil may have contagious effect on Spain * Fed meeting on Wednesday significant for dollar * Bank of Japan expected to ease further By Julie Haviv NEW YORK, Dec 10 (Reuters) - The euro rose against the dollar for the first time in four sessions on Monday as Italy's prime minister tried to allay fears about his country's outlook, but concerns about the euro zone's economy should keep the currency under pressure. The euro had been weighed early in the day by a spike in Italy's borrowing costs after Mario Monti said on Saturday he would resign once the 2013 budget passes. An election in February looks probable, with investors worried about who will navigate the euro zone's third-biggest economy out of the debt crisis. The euro, however, gained ground after Monti tried to reassure rattled financial markets that Italy would not be left adrift following his surprise decision to resign and Silvio Berlusconi's return to frontline politics. Some analysts noted that the bond and currency markets' reaction to Italy's news may have been overdone, given the fact that Monti would have called for elections in a few months anyway. His decision simply expedites the process. "The markets over reacted to the weekend news and so now we are seeing a pullback and somewhat of a 'risk on' climate," Sebastien Galy, FX strategist at Societe Generale in New York. "We are range trading for the most part and fading some of the euro zone risk," he said. The euro was last flat on the day against the yen at 106.58 yen after dropping as low as 105.94 yen, its weakest point in about two weeks. Against the dollar, the euro was last up 0.4 percent at $1.2942. "Given the chaotic history of Italian politics, it is almost certain that whoever is elected prime minister will not be able to exercise anywhere near the level of control over the country's fiscal policy enjoyed by Mr. Monti," said Boris Schlossberg, managing director of FX strategy at BK Asset Management, in New York. While Italy has nearly completed its planned bond market funding for this year, the latest political turmoil could hinder its ability to borrow around 420 billion euros in 2013. There could also be an impact on neighboring Spain, whose government is studying the need for outside help. Concerns about core euro-zone countries also weighed on the common currency. Germany's Bundesbank last week slashed its growth outlook for Europe's largest economy. The euro was also pressured by data showing that Germany posted its narrowest trade surplus in more than half a year in October. A dismal economic landscape in the euro zone has many analysts forecasting another rate cut from the European Central bank early next year, which should limit euro gains even if the United States avoids the so-called "fiscal cliff". If the White House and Congress cannot agree on a deficit reduction deal by the end of the year, massive tax hikes and spending cuts will take hold next year. If this "fiscal cliff" is not averted, many analysts believe the U.S. could slide into another recession. The dollar, however, could thrive due to its safe-haven status. The White House and House of Representatives Speaker John Boehner's office held more negotiations on Monday on ways to break the fiscal cliff stalemate, but Republicans said they were still seeking a new offer from President Barack Obama. FED FOCUS Caution that the U.S. Federal Reserve may take fresh steps on monetary easing later this week limited the dollar's advance. The dollar index was down 0.1 percent at 80.338. Many economists expect the Fed to announce on Wednesday monthly bond purchases of $45 billion, signaling it will keep pumping money into the economy to bring down unemployment. That should be bearish for the dollar in general. Bob Lynch, global head of FX strategy at HSBC in New York, said the Fed's likely announcement of further asset purchases on Wednesday may not overly pressure the dollar as the market has already factored it in, but over the longer term, the negative effect would be more pronounced. "We view the Fed's asset purchases and the effective monetization of government debt as debasing to the dollar, undermining its reserve currency status in a manner that will ultimately be reflected in some lowering of its exchange-rate value," Lynch said. Data showed speculators' net yen short positions last week rose to their highest level since mid-2007. With short bets already stretched, traders said it would be difficult for the dollar to advance against the Japanese currency. The Bank of Japan will probably ease monetary policy next week, sources say, as looming risks such as the potential fallout from the U.S. fiscal cliff and slow Chinese growth continue to cloud the outlook for an economy already seen as in recession. The dollar last traded up 0.1 percent at 82.38 yen yen, according to Reuters data.