* Euro drops to one-week low after euro zone, German data
* Dollar index rallies to two-week high
* Yen steadies but seen vulnerable vs dollar
LONDON, Oct 24 (Reuters) - The euro fell to a one-week low against the dollar on Wednesday after worse-than-expected German business activity and sentiment data fuelled concerns of weakness in the euro zone's largest economy.
Purchasing Managers' Index data showed activity in the euro zone as a whole also contracted more sharply than forecast in October, suggesting the currency bloc's economic decline was deepening.
The single currency extended losses after a German Ifo survey showed a sixth successive drop in October to fall to its lowest level in more than 2-1/2 years.
The euro fell to a session low of $1.29205, before paring losses to last trade down 0.4 percent on the day at $1.2942``.
It held between the recent range of $1.28 to $1.3170 that it has traded in since mid-September, while strong technical support was expected at $1.2835, the 200-day moving average.
''We had the PMI data in European markets and the Ifo index readings which were lower than expected, that pulled the euro lower in two phases,`` said Antje Praefcke, currency analyst at Commerzbank.
Markit chief economist Chris Williamson said the PMI survey data suggested German growth had contracted in the third quarter and would in the fourth, which would put the country in recession.
Euro weakness also helped the dollar index hit a two-week high Of 80.151. Against the yen, the euro fell to 102.99 yen, its lowest level in a week.
Commerzbank's Praefcke said the euro could gain support later in the session when European Central Bank president Mario Draghi faces questions from German lawmakers.
Draghi is likely to face a grilling on the ECB's bond-buying plan to ease the debt crisis that has faced fierce opposition from some in Germany.
''Investors will also be watching Draghi in Berlin later, which could see him try to push it (the euro) higher,`` she said.
Expectations that indebted Spain is moving closer to asking for a bailout, enabling the ECB to buy its bonds and lower borrowing costs, have helped support the euro in recent weeks. Uncertainty about when that request might come has also deterred investors from chasing the single currency higher, however.
''Investors are not very happy to put on long euro positions because of the uncertainty in Spain and worries about the euro zone economy,`` said Niels Christensen, currency strategist at Nordea in Copenhagen.
The dollar edged away from the psychologically key level of 80 yen, dipping 0.1 percent on the day to 79.79 yen.
Speculation of more monetary easing from the Bank of Japan on Oct. 30 has weighed on the yen in recent sessions and helped the dollar hit a three-month high of 80.02 yen on Tuesday.
Although some traders have begun reducing their bullish bets on the dollar against the yen this week, others who missed out on the recent move seemed to be looking for opportunities to buy, said a trader for a major Japanese bank in Singapore.
The trader cited a mixture of dollar buying orders and stop-loss sell offers at levels around 79.50 yen. There was also heavy demand to sell the dollar reported above 80 yen, that could hamper further gains.
Meanwhile the Australian dollar edged up as consumer price figures showed an unexpected uptick, dampening expectations the central bank will lower rates at its next meeting.
The next focus for investors will be the Federal Reserve's policy statement, due at 1815 GMT.
The Fed was expected to continue with its programme of easy monetary policy, having already indicated it would take more than a modest show of economic strength for policymakers to consider changing their stance.