* Single currency steadies vs dollar, outlook clouded
* Euro struggles vs higher-yielding commodity currencies
* Approval of Spanish bank bailout expected later
By Nia Williams
LONDON, July 20 (Reuters) - The euro eased against the U.S. dollar and hovered near a record low versus the Australian dollar on Friday, looking vulnerable to further losses as investors fretted about Spain's fiscal woes and favoured currencies with a higher yield.
Weak demand at a Spanish bond auction on Thursday pushed 10-year government debt yields back above 7 percent, a level seen as unsustainable, intensifying doubts over whether Madrid can avoid a full-blown bailout.
Market players said the expected approval of a Spanish banking bailout later in the session was unlikely to halt the rise in debt yields, and consequently do nothing to stem euro weakness.
"We have still got a market that fundamentally does not believe Spain will be in a position to support itself going forward. The euro will probably stay in a range today but pressure will return to the downside," said Simon Derrick, head of currency research at Bank of New York Mellon.
The euro dipped 0.1 percent to $1.2270, holding above last week's two-year low of $1.2162. Derrick said he expected a test of $1.2150 next week.
Besides concerns about the euro zone's sovereign debt crisis, the euro took a hit this month after the European Central Bank lowered the deposit rate, which acts as the floor for euro zone money market rates, to zero.
Two-year bond yields have dipped into negative territory in core triple-A rated Germany and the Netherlands. The negative interest rates could prompt investors who are bearish on the euro's outlook to shift money elsewhere to secure some return on capital, market players said.
"If you believe we have a long period of highly accommodative policy in Europe you might as well go on a search for yield elsewhere," said BNY Mellon's Derrick.
The euro traded steady against the Australian dollar at A$1.1772, near Thursday's record low around A$1.1735. It also hovered near record lows against the New Zealand dollar and Canadian dollar, both of which were struck on Thursday.
COMMODITY CURRENCY STRENGTH VS EURO
Many analysts said the fact commodity currencies were rallying against the euro despite concerns Chinese growth is slowing was a sign that weakness in the single currency could continue.
"I think there is a bit of a theme going on, and the biggest single mover is central bank reserve diversification out of the euro, and into especially Aussie," said Jesper Bargmann, head of spot foreign exchange for RBS in Singapore.
The potential for another round of quantitative easing from the U.S. Federal Reserve may help support commodities and the Australian dollar, while the euro should continue to stay weak due to concerns over the euro zone's debt crisis, he added.
Speculation the Fed may opt for another round of monetary easing to boost growth, which would increase the supply of dollars in the system, was also slowing the euro's decline against the U.S. currency.
The ECB deposit rate cut and subsequent drop in money-market rates has also stirred talk of euro-funded carry trades, in which investors effectively borrow low-yielding currencies to invest in higher-yielding currencies and assets.
"The euro is being viewed as a funding currency and there are increasingly active moves on the back of that," said a trader for a major Japanese bank in Bangkok.
The euro held steady versus the Japanese yen at 96.44 , after recent selling by institutional investors, market players said. The dollar was also close to flat versus the yen at 78.56 yen, still near Thursday's six-week low of 78.42 yen.
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