* Euro rises 1 percent to two-week high versus dollar * ECB head: Will do whatever needed to save euro * Analysts wary of euro rally, Spanish yields near 7 pct By Wanfeng Zhou NEW YORK, July 26 (Reuters) - The euro headed for its best day against the dollar in a month on Thursday after European Central Bank chief Mario Draghi said the bank would do whatever it takes to protect the euro zone from collapse and preserve the single currency. Speculators pared back their extended short positions in the euro, lifting it more than 1 percent to a high of $1.2329, nearly 3 cents above a two-year low set earlier this week. Some analysts see further near-term gains, saying Draghi's comments represented a significant shift in the ECB's policy stance, but others say any rally is set to fade until the bank takes real action to ease the euro zone's debt crisis. "The market appeared to be primed for any positive developments from the euro zone," said Neal Gilbert, market strategist at GFT in Grand Rapids, Michigan. "Despite the strong comments by Draghi, the risks of debt contagion within the euro zone remain," he said. "It probably won't be very long lasting until the ECB actually takes action instead of jawboning the market." The euro rose to a two-week high of $1.2329, according to Reuters data, and was last up 1 percent at $1.2282. It also rallied 1.1 percent to 96.04 yen, moving away from a 12-year low set earlier this week. Speaking to an investment conference in London, Draghi pledged to do whatever was necessary to protect the euro zone from collapse, including fighting unreasonably high government borrowing costs for countries such as Spain and Italy. "In a heavily biased market, it only takes a little bit of news of the opposite sentiment to provoke quick moves," said Christopher Vecchio, currency analyst at DailyFX in New York. Vassili Serebriakov, currency strategist at Wells Fargo in New York, said Draghi sent a "loud and clear" signal that European authorities are unwilling to tolerate a significant further rise in the borrowing costs for peripheral euro-zone countries. Spanish and Italian government bond yields fell sharply on Draghi's comments, although the rally failed to bring 10-year Spanish yields much lower than 7 percent, which is widely seen as an unsustainable level in the long run. U.S. DATA AND THE FED Some analysts cautioned the past two days' gains may have been overdone, noting that the euro could re-test recent lows and target the psychologically important $1.20 level followed by 2010's low around $1.1875. Investors are increasingly worried about the possibility of Spain applying for a sovereign bailout or Greece leaving the monetary union. Greece has scraped together a plan to save nearly 12 billion euros over the next two years in an increasingly desperate effort to convince visiting EU and IMF inspectors it deserves to be saved rather than pushed out of the euro zone. . The biggest U.S. prime money market funds reduced their euro-zone exposure to the lowest level since 2006 as fears about Spain requiring a full-blown bailout intensified, Fitch Ratings said in a report on Wednesday.. Investors will likely turn their attention to a report on U.S. second-quarter growth on Friday and a Federal Reserve policy meeting next week. Data earlier showed the number of Americans filing new claims for jobless benefits fell last week to nearly a four-year low, but an unusual pattern for summer factory shutdowns kept hopes in check that the weak labor market was improving. Other data showed new orders for long-lasting U.S. manufactured goods rose in June although a gauge of planned business spending plans dropped, pointing to a slowdown in factory activity. [ID: nL2E8IQ06N] "More evidence that the U.S. economy cannot reach 'escape velocity' could intensify speculation for more accommodation from the Fed and help euro/dollar consolidate some more ahead of next Wednesday," Citigroup strategists wrote to clients. "We also think the short squeeze in the euro has further to run, given that the single currency still looks oversold relative to fundamentals," the bank said. The dollar rose 0.1 percent to 78.20 yen, but fell to a two-week low against the Swiss franc. The New Zealand dollar rallied 1.7 percent and Australian dollars gained 0.9 percent as risk appetite increased.