* Euro hits day's low after Ifo falls short of expectations
* Yen stays on back foot after N.Korea nuclear test reports
* Market liquidity thin due to holidays in UK, U.S.
(Releads, updates throughout; previous TOKYO)
By Naomi Tajitsu
LONDON, May 25 (Reuters) - The euro slipped against the dollar on Monday, stung after a gauge of German corporate sentiment fell short of market expectations, suggesting that any recovery in the euro zone's biggest economy would take more time.
The yen stayed under selling pressure after reports that North Korea had conducted a nuclear test, followed by test-firings of three short-range missiles, had been seen as a negative factor for the currency, given Japan's geographical proximity to Pyongyang.
In thin trade due to market holidays in the UK and the United States, the euro slipped to the day's low after the Munich-based Ifo think tank's business climate index rose to 84.2 in May from 83.7 in April.
Despite the rise, the reading was lower than expectations for an 85.0 reading, while current conditions slumped to their lowest level since Germany's reunification in 1990.
Losses in the euro were limited, however, as many in the market continue to focus on the dollar's short-term decline on the back of fiscal concerns given recent speculation that the United States may be vulnerable to a credit ratings adjustment.
Analysts said that the euro's slide on Monday suggested that traders may be getting less optimistic that the global economy is beginning to recover significantly.
This view had improved risk demand in past weeks and propelled the single European currency to its highest level against the dollar in nearly five months last week.
"The Ifo was disappointing because it confirms that what's been happening in the financial markets so far is very much been based on hope, and not hard facts," said Michael Klawitter, senior currency strategist at Dresdner Kleinwort in Frankfurt.
The business climate index rose for the second consecutive month, which Klawitter noted was an improvement, but he added that bigger rises in expectations in past months while current conditions deteriorate was evidence that people may be more confident of a recovery than perhaps they should be.
"Overall, the bottom (of the downturn) may have been reached, but it remains questionable whether there is any basis for optimism that will move into a normal recovery phase," he said.
YEN SLIPS
By 1207 GMT, the euro traded at $1.3990, flat on the day and hovering near a session low of $1.3959. The pair pulled away from $1.4051 hit late last week for the first time since early January.
Despite the euro's slide on Monday, some in the market said it was too early to determine whether the rally in the single currency had petered out, given the lack of liquidity on Monday due to market holidays.
The dollar inched up 0.1 percent against a basket of currencies but held near a five-month low hit last week when concern that U.S. government debt may lose its AAA rating prompted investors to sell the world's reserve currency.
The dollar rose 0.3 percent to 95.10 yen, trading near the day's high around 95.20 yen hit earlier in the day on the North Korea news.
European market participants said that the news was having limited impact on the local market. Traders in Tokyo had said that yen selling had been exaggerated by after some in the market used the news to unwind long yen positions.
The yen stayed on the back foot against other currencies, prodding the euro 0.4 percent higher to 133.201 yen, while sterling rose 0.2 percent.
The UK currency slipped 0.1 percent to $1.5910, trading just under a 6 1/2-month high of $1.5947 touched on Friday.
The pound has recovered from some selling seen last week after Standard & Poor's said the outlook for Britain's triple-A credit rating was "negative" and no longer "stable". Focus now has shifted to other countries which may be at risk of a similar adjustment, with some pointing out that the U.S. fiscal position is much weaker than Britain's.
Given ongoing concerns about ballooning U.S. debt levels, markets awaited the U.S. Treasury's two-, five- and seven-year debt auctions this week totalling $101 billion -- an important test of investor appetite for dollars and dollar assets.
"More Treasury auctions will be held this week and their continued success will be critical for the dollar outlook as the results will also reveal the situation with external demand," UBS analysts said in a research note.
They added that if the indirect bidders show material signs of falling demand, it would suggest that sovereign bidders may be starting to lose patience with dollar, and U.S. current monetary and fiscal policies by association.
Market participants said that selling of the dollar and U.S. assets last week was a reflection of growing concerns about the U.S. government's heavy indebtedness as it grapples with the worst financial crisis in generations. (Reporting by Naomi Tajitsu; Editing by Victoria Main)