* ECB stress test points to limited capital shortfall among banks

* Yen hits two-week lows as risks appetite returns

* German business sentiment index next major focus

By Hideyuki Sano

TOKYO, Oct 27 (Reuters) - The euro held firm in early Monday trade after the European Central Bank's stress tests found smaller capital shortfalls among European banks than expected.

Twenty-five out of the euro zone's 130 top lenders failed landmark health checks at the end of last year but most have since repaired their finances, the ECB said on Sunday.

Painting a brighter picture than had been expected, the ECB concluded that banks' capital holes had chiefly been plugged, leaving only a modest 10 billion euros to be raised.

The euro traded at $1.2679, up slightly from late U.S. levels on Friday, extending its recovery from two-week low of $1.2614 set on Thursday.

The common currency also briefly rose to 137.48 yen , its highest level in more than two weeks.

The low-yielding Japanese currency was soft also on resurgent risk appetite after upbeat earnings from big names helped the world's shares the biggest gains in more than a year after four straight weeks of losses.

The dollar rose to as high as 108.38, its highest level since Oct 8.

The growth-linked Australian dollar edged up 0.2 percent in early trade to stand at $0.8802.

Still, moves in early Monday trade were limited overall, due to lingering concerns on the state of the global economy as Europe, China and Japan all appear to suffer one problem or another.

Although fears of a possible recession in the euro zone eased slightly after a surprisingly strong business survey last week, few investors think Europe is out of woods.

Traders will be looking to Germany's Ifo business sentiment index due at 0900 GMT on Monday. Economists expect a slight fall in business morale.

Looking further ahead, policy meetings by the U.S. Federal Reserve and the Bank of Japan later this week attract attention on clues on how they perceive latest threats to the economy.

"The Fed will likely end its bond buying while maintaining its pledge to leave rates near zero for a considerable time. That should underpin risk assets and hamper the yen," said Minori Uchida, chief FX strategist at the Bank of Mitsubishi-Tokyo UFJ.

Elsewhere, the Brazilian real's non-deliverable forwards showed a muted response so far after leftist President Dilma Rousseff narrowly won re-election on Sunday.

Investors have generally disliked Rousseff's interventionist management of state-run companies and other sectors of the economy, but some traders think her re-election is already priced in as the real has fallen nearly 10 percent since early September.

(Editing by Eric Meijer)