* Euro rises on narrowing spread of Greek vs German debt
* Aussie down as RBA surprises and holds rates at 3.75 pct
* Market awaits White House adviser Volcker's testimony (Recasts, updates prices)
NEW YORK, Feb 2 (Reuters) - The euro rose against the dollar on Tuesday, supported by a narrowing in Greek government bond yield spreads over German debt, ahead of the European Commission's reaction to Greece's internal plan to strengthen its finances.
Greek Prime Minister George Papandreou said the level of Greek and euro zone bond spreads was "completely unjustified," keeping up the rhetoric against speculators he blames for targeting his country.
The comments came ahead of the publication on Wednesday of EU recommendations to Athens on its austerity plan. The Commission's much-anticipated assessment is likely to be in line with what Greece itself has promised to do in its long-term deficit-cutting plan.
The Australian dollar fell after the Reserve Bank of Australia surprised investors by leaving its benchmark interest rate unchanged at 3.75 percent. There had been almost universal consensus the central bank would raise it to 4 percent.
"Bond market fears over Greece reached a high last Thursday and have since fallen back," said Camilla Sutton, senior currency strategist at Scotia Capital in Toronto. "This hints that the market is stabilizing and that much of the bad news is now priced in."
Midway through the New York session, the euro recovered from early losses to trade 0.1 percent higher on the day at $1.3946, recovering from a seven-month low hit on Monday and almost exactly where it was as the New York session opened.
Greek 10-year yield spreads over Bunds were at 353 basis points, off a session low of 327. Last week, the spread expanded beyond 400 basis points, its widest since Greece adopted the euro in 2001.
The slide in confidence in Greece triggered selling in its government bonds, blowing out its yield spread with German bond.
But euro gains were capped by concern that deficits in other euro zone countries, such as Portugal, would keep investors wary of taking big positions in the euro zone common currency.
"Sentiment remains fragile despite the strong U.S. GDP data last week, and the Greek situation is still in the background, making investors cautious," said Paul Robson, currency strategist at RBS.
Underlining the possibility that fiscal woes may extend beyond Greece, European Central Bank Governing Council member Vitor Constancio said on Tuesday Portugal's economy required "significant adjustments."
The dollar index, a calculated measure of the dollar's performance against six currencies, slipped 0.2 percent to 79.070, but was still near a six-month high hit on Monday. The dollar was 0.3 percent lower against the yen at 90.30 yen.
AUSSIE DOWN
The Australian dollar fell to a low of US$0.8780 before paring losses to trade at US$0.8826, down 1 percent in the global session after the RBA decision.
The Australian dollar held above US$0.8735, which analysts said was a key level to watch, given that a fall below that would take the currency to its lowest in four months.
Some analysts said a general improvement in risk sentiment, albeit slight, would limit Aussie losses in the near term, and they expected the currency to remain in demand, particularly given the RBA left possibility open for future rate hikes.
"Investors may look to use the dip ... as a buying opportunity given that broader 'risk' sentiment appears to be improving and positioning is not stretched," Citi analysts said in a note.
"This suggests there may only be limited scope for stop-loss-driven selling and position unwinding to drive AUD lower. On balance, we believe it is unwarranted to shift away from a positive view on AUD."
Risk sentiment will be under scrutiny later when White House adviser Paul Volcker appears before the Senate Banking Committee to defend the administration's proposal to limit risk-trading by banks, which spooked investors and triggered a sell-off in equities when it was unveiled last month.
According to testimony obtained by Reuters, Volcker will urge Congress to curb the risks taken by large banks to help prevent them from being treated as "too big to fail".