* Dollar recovers from last week's 5-month low
* Concern over German banking sector hits euro
* Focus turns to U.S. Treasury auctions this week
(Updates throughout, adds quotes and comment)
By Jamie McGeever
LONDON, May 26 (Reuters) - The dollar strengthened on Tuesday after a media report questioning the health of the German banking system prompted traders to cash in on the euro's recent rally that culminated in a five-month high last week.
The report in Britain's Daily Telegraph was prominent among reasons given for the euro's slide of almost one percent to below $1.39, another being the relatively disappointing euro zone economic data in recent days.
North Korea's missile test on Tuesday also encouraged investors to pare back exposure built up in recent weeks across various asset classes, which meant buying back dollars and government bonds, and selling euros, stocks and commodities.
"There is some profit taking here ... the euro/dollar rally of last week was a bit excessive," said David Powell, G10 currency strategist at Bank of America-Merrill Lynch in London.
Powell said the story on German banks didn't contain any new information, but was enough to encourage traders to book profit from the euro's rise above $1.40 last week.
"It's certainly adding to the negative euro outlook (today)," Powell said.
The Daily Telegraph reported that Germany's financial regulator BaFin had warned that toxic debt of the country's banks would blow up "like a grenade" unless they took advantage of government bad-bank plans to prepare for the next phase of crisis.
The report was not new, however, as the regulator warned last week that German banks have bad assets of around 200 billion euros ($280 billion).
At 1000 GMT the euro was down 0.8 percent on the day at $1.3890. On Friday it rose as high as $1.4051 on trading platform EBS, its highest since early January, marking a rise of some 8 percent from $1.30 in the past month.
The dollar index, a gauge of the greenback's performance against six other major currencies, was up 0.8 percent on the day at 80.62.
On Friday it fell to a 2009 low of 79.805, a day after an outlook downgrade to Britain's AAA sovereign debt rating prompted speculation the U.S. government debt may lose its top-notch rating.
CENTRAL BANK FOCUS
European markets were open on Monday, however, and German-based Ifo think tank's business climate index fell short of market expectations, suggesting that any recovery in the euro zone's biggest economy will take more time.
Figures on Tuesday confirmed that Germany's economy shrank in the first quarter at its fastest pace since reunification in 1990, while euro zone industrial new orders fell unexpectedly in March.
The euro was down 0.8 percent on the day at 131.85 yen, while the dollar was up 0.2 percent against the Japanese currency at 95.00 yen.
A greater test of dollar sentiment comes later in the week with the U.S. Treasury's note auctions totalling $101 billion. The government will sell two-year notes today, five-year notes on Wednesday and seven-year paper on Thursday.
"The main risk .... is whether sovereign bidders finally lose appetite and shift their focus," said UBS in a note on Tuesday.
"As such, a low indirect bidder participation rate during this week's auctions may also damage the dollar, but we also note that it is not in the interests of the world's major reserve holders to act disruptively at this stage," it said.