FOREX-German bund sell-off lifts euro towards 2-month highs vs dollar

* Dollar under fresh pressure after weak trade data

* Big trade deficit could mean negative Q1 GDP

* Rising Bund yields support euro (Adds PMI details, quote)

By Anirban Nag

LONDON, May 6 (Reuters) - The euro rose towards recent two-month highs against a softer dollar on Wednesday, underpinned by rising German 10-year Bund yields that hit their highest this year and narrowed the gap over U.S. Treasuries.

It was also helped by business surveys that pointed to a solid pick up in euro zone activity and news that Greece made a 200-million-euro interest payment to the International Monetary Fund that fell due on Wednesday.

The yield gap between U.S. 10-year Treasury yields and their German counterpart shrank to about 165 basis points, the narrowest since late March, making the euro more attractive to investors chasing yields.

The euro rose to $1.1271 in European trade, edging back towards a two-month high of $1.1290 set on Friday. It was last trading at $1.1236, still up 0.45 percent on the day and well above 12-year lows of $1.0457 struck in April.

"The sell-off in Bunds and the rising yields is helping euro/dollar," said Yujiro Goto, currency strategist at Nomura. "We think, given how significantly short the market is on the euro, there is scope for the euro to rise further in the short term, especially if the sell-off in Bunds continues."

Benchmark 10-year Bund yields traded at 0.58 percent, having hit a record low of 0.05 percent last month, when many expected them to turn negative due to the impact of the European Central Bank's trillion euro bond buying programme.

Derek Halpenny, European head of global market research at Bank of Tokyo Mitsubishi said a recent spike in crude oil prices had boosted inflationary expectations within the euro zone.

"If it were to continue more and more market participants would question the longevity of the ECB quantitative easing programme which is purely justified on the grounds of inflation and inflation expectations being too low," he added.

The QE programme has been a prime reason behind the euro's drop to 12-year lows against the dollar.

Mitul Kotecha, head of currency strategy for Asia-Pacific at Barclays (LSE: BARC.L - news) in Singapore, said recent moves in yield differentials seemed to be weighing on the dollar.

"We are seeing U.S. yields higher, but at the same time yields elsewhere are also rising," he said. "Even though U.S. yields are moving higher, the differential certainly with the likes of the euro and Aussie dollar has worsened," Kotecha said.

The dollar index fell 0.4 percent to 94.687. The greenback was also on the defensive after disappointing U.S. trade data for March painted an even bleaker picture of the economy in the first quarter.

Later on Wednesday, the focus will shift to a U.S. private-sector employment report that may affect expectations for Friday's U.S. non-farm payrolls data. Recent indicators, including a drop in jobless claims to a 15-year low in the week ended April 25, point to an improvement in the labour market. (additional reporting by Masayuki Kitano; Editing by Andrew Heavens)