FOREX-Euro near 3-1/2 month low vs dlr as Greece wrangles

* Euro in sight of Jan. 23 low, focus on $1.29 option barrier

LONDON, May 11 (Reuters) - The euro hovered near a 3-1/2-month low on Friday as Greek political parties made efforts to form a coalition government, and looked fragile as risk sentiment struggled on weak Chinese data and JPMorgan's shock trading losses.

The common currency was steady at $1.2936 after earlier hitting a trough of $1.2905, its lowest level since Jan. 23. Investors were heavily focused on Greece, where inconclusive election results on Sunday threw the country into political disarray and raised the risk of it exiting the euro zone.

The euro climbed to a session high of $1.2956 as Greek conservative leader Antonis Samaras said there were still hopes a government could be formed, but came further pressure when the leader of the moderate Democratic Left said the country was heading for a repeat poll.

Analysts said many market players were resigned to further political uncertainty in Greece, meaning the euro would probably grind lower against the dollar rather than drop suddenly.

"The market does not feel there's any sense of urgency, investors have come round to the idea of the probability of another election," said Derek Halpenny, European head of currency research at Bank of Tokyo-Mitsubishi.

"But the net result is we are in a far worse position now than prior to the election. The probability of Greece not being in the single currency by the end of this year is considerably higher and that eliminates risks to the upside in euro/dollar for the next few months."

Traders said a reported euro option barrier at $1.2900 was the near term focus on the downside, while offers at $1.2980 were likely to check near term gains.

Concerns about the euro zone economy prompted Goldman Sachs to downgrade its six-month euro forecast to $1.33 from $1.38, arguing a European policy response to the debt crisis would ultimately stabilise the common currency, but the process may take longer than initially thought.

The euro and growth-linked currencies were hit earlier in the session as investors shunned risky assets after JPMorgan Chase & Co said it suffered a trading loss of at least $2 billion from a failed hedging strategy.

Both the dollar and the yen, safe haven currencies that tend to strengthen in times of market stress, rose. The euro was close to flat on the day at 103.40 yen, not far from a three-month low of 102.76 yen hit earlier this week.

SPAIN CONCERNS

Mounting concerns about the Spanish banking sector and the government's ability to check its budget deficit also weighed on the euro and left investors fretting about whether the debt crisis will ensnare the euro zone's fourth-largest economy.

The European Union's executive Commission forecast Spain would miss its 2012 deficit target by a big margin, and saw Spain's deficit rising to 6.4 percent of gross domestic product from a previous estimate of 5.9 percent.

Market players said any boost from a solution to the Greek political deadlock could prove to be fleeting as concerns about Spain's banking sector would drive investors to take a bearish view on the euro.

"The Spanish banks' problems and now the souring risk dynamics are all negative for the euro. All this means that the U.S. dollar and the yen will be supported," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

The dollar index was last up 0.15 percent at 80.238, having hit a two-month peak of 80.336 earlier in the session.

Adding to the negative tone across financial markets, Chinese industrial production weakened sharply in April as investment slowed to its lowest level in nearly a decade, coming in well below forecasts.

The Australian dollar, which is sensitive to news from China, Australia's largest export market, looked set to drop below parity against the U.S. dollar. It was last down 0.3 percent at $1.0036, having fallen to $1.0018, its lowest level in nearly five months.