NEW YORK (Reuters) - The euro rose against the dollar on Friday after most euro zone banks passed stress tests, though analysts worried the checks were not strict enough to reveal the true health of the sector.

The four top French banks and all but one German bank were judged to have sufficient capital cushions to survive potential losses on their sovereign debt holdings.

Seven of 91 banks failed the tests, including ones in Greece and Spain, for an overall capital shortfall of $3.5 billion euros.

The euro initially fell as results trickled in and investors worried the tests were not rigorous enough. Most took issue with a decision to apply losses only to debt held on banks' trading books, not on those bonds held to maturity.

But the single currency recovered late in New York, rising 0.2 percent to $1.2913 , thanks to strong euro zone economic data and a US stock market rally that stoked appetite for risk.

"There's definitely suspicion out there about these tests, but the euro is coming off a very good week thanks to solid economic data, and that's lending support," said Brian Dolan, chief strategist at Forex.com in Bedminster, New Jersey.

Fear of a euro zone debt crisis and its impact on European banks drove the euro below $1.19 last month, its lowest level since 2006. But it began a swift recovery in July and hit a 10-week high above $1.30 earlier this week.

That was partly driven by data showing the euro zone economy has been holding up better than anticipated, even as governments tighten their belts to reign in large deficits.

Data on Friday showed German business sentiment staged a record jump in July to its highest level in three years.

Recent US housing and manufacturing data, meanwhile, has suggested a recovery may be fizzling, dashing investor hopes for higher US interest rates this year and dulling the appeal of dollar-denominated assets.

Against the yen, the euro rose 0.6 percent to 112.80 yen while the dollar added 0.5 percent to 87.35 yen .

Sterling rose 1.1 percent to $1.5420 boosted by data showing Britain's economy grew almost twice as quickly as expected in the second quarter. .

Analysts said the euro looked vulnerable in the long run.

"The simple fact that the stress tests only evaluated the sovereign debt that the banks traded, rather than the sovereign debt that the banks held on their balance sheets really, in my opinion and in a lot of people's opinions, makes the tests not a valid measure of solvency," said Greg Salvaggio, vice-president of trading at Tempus Consulting in Washington.

Win Thin, senior currency strategist at Brown Brothers Harriman in New York, said the stress tests "weren't particularly stressful".

For instance, he said that since most analysts fear Greece will eventually have to restructure its debt, it makes no sense to assume lenders will be paid off at par if Greek bonds are held to maturity.

Mr. Salvaggio predicted a euro retreat to $1.2750 over the coming days, and Dolan said the real test would come today, when investors get a look at European interbank lending rates.

If these rise, he said, the euro may struggle.

"You could start to see a two-tiered banking system in which some have sufficient capital and can borrow, while another group has to pay a big premium to borrow and may not be able to borrow at all," he said.