* Euro rises as yields drag down dollar
* Central banker speeches keep markets edgy
* Traders brace for German, Italian political developments
* Graphic: World FX rates in 2018 By Tommy Wilkes
LONDON, Feb 26 (Reuters) - The euro gained on Monday as a fall in U.S. Treasury yields dragged down the dollar, but trading was relatively quiet ahead of speeches by central bankers and political developments in Germany and Italy this week.
With the dollar's bounce since it hit a three year-low on Feb. 16 fizzling out, the euro was able to rise 0.3 percent to $1.2334 .
The currency has rallied this year on the back of dollar weakness and expectations that the European Central Bank will tighten monetary policy but with the rally running out of steam as the dollar recovered, the euro remains 2 cents off recent highs of more than $1.25. Analysts said investors were cautious about taking big positions this week due to political risks.
Italians vote in a national election on Sunday, while the leading political parties in Germany, Europe's biggest economy, will decide on a coalition deal that could secure Angela Merkel a fourth term as chancellor. "We think the market may be underestimating the risks here - especially given that the euro's pro-cyclical and portfolio inflow-driven rally could run out of steam if political risks stay slightly elevated in the near-term," ING said in a note.
Analysts pointed to weekly futures data that showed net long positions in the euro had fallen for a third week. European Central Bank President Mario Draghi's appearance in the European Parliament on Monday and euro zone inflation data due later this week also added to a nervous outlook for euro trading.
Commerzbank's FX strategist Thu Lan Nguyen said that she expected the euro to trade narrowly until there was clarity about the political situation in Italy and Germany.
"You can see the activity in the options market. You do see that hedging activity has picked up. It's up but it's not comparable to what we saw before the French election (last year)," Nguyen said, referring to protection against euro weakness.
The dollar index, which measures the greenback against a basket of six major rivals, eased 0.2 percent to 89.685 .
It hit a three-year low near 88.25 on Feb. 16 but the view that the sell-off was overdone, plus upbeat minutes from the U.S. central bank, helped lift the dollar last week.
POWELL'S TESTIMONY
The focus this week is Federal Reserve Chairman Jerome Powell's first congressional testimony. Worries about rising inflation have spooked markets on a multi-year bull run. Investors will be scanning Powell's comments for any signs that the central bank wants to raise rates faster to address inflationary pressures.
On Monday, the dollar was weighed down by a drop in the U.S. 10-year Treasury yield.
The U.S. 10-year Treasury yield eased in Asian trade to 2.858 percent , continuing a slip from the four-year high of 2.957 percent reached on Wednesday.
The dollar fell 0.1 percent versus the yen to 106.65 yen.
While stock markets started the week on a solid footing and pointed to strong risk appetite, futures data suggested foreign exchange investors were cutting their risk exposures, albeit from high levels.
Positions in risk-related foreign exchanges, particularly sterling and the Canadian dollar, fell, according to the data.
(Editing by Robin Pomeroy)
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