* Yen trims losses after biggest drop vs dlr since 1974
* Nikkei soars 7 pct on reports BOJ may cut rates this week
* Japan exporters, investors sell into dollar's rebound
By Eric Burroughs
TOKYO, Oct 29 (Reuters) - The yen edged up on Wednesday after suffering one of its biggest drops against the dollar ever the previous day as reports the Bank of Japan could cut interest rates this week sparked a hefty stock rally and a recovery in investor appetite for risk.
Japan's central bank is considering cutting rates from the already low 0.5 percent at Friday's policy meeting, a source told Reuters, joining an expected round of rate cuts in coming days as central banks grapple with a darkening global economic outlook.
The move would come after Group of Seven powers issued a rare warning earlier this week singling out the yen's surge as a threat that could further destabilise financial markets and the global economy.
The G7 action was seen as giving Japan the scope to intervene in currency markets to weaken the yen, which has soared to a 13-year peak against the dollar and all-time high against the Australian dollar as investors have dumped carry trades.
Japan's low interest rates have made the yen popular for years as a source of cheap funds for carry trades -- borrowing the yen to buy everything from higher-yielding currencies to stocks and commodities.
Analysts said a BOJ rate cut would likely have little impact on the Japanese economy or the yen but would send a message that it was acting more in concert with other major economies in dealing with the worst financial crisis in 80 years.
"A rate cut would send a message to the world that Japan is cooperating with other nations in tackling the financial crisis. Now that the news is out, markets would be hugely disappointed if the BOJ didn't cut rates," said Koichi Haji, chief economist at NLI Research Institute.
The yen's jump this month has compounded the slide in the Nikkei share average to a 26-year low, creating a vicious circle that analysts see as a major factor behind this week's official response.
The reports of the BOJ rate cut, along with a huge rally on Wall Street, drove the Nikkei up nearly 8 percent at one point on Wednesday.
The dollar fell 0.5 percent from late U.S. trade to 97.50 yen after having surged as high as 99.79 yen on trading platform EBS but well above the 13-year low of 90.87 yen struck last week.
On Tuesday the dollar soared 6.4 percent against the yen -- the biggest one-day gain since 1974.
Traders said Japanese exporters stepped in to sell the dollar as it approached the 100 yen level. In reporting quarterly earnings this week, exporters such as Canon Inc and Panasonic Corp said they were using the 100 yen level as a target rate for their business planning.
"Japanese exporters see it as an opportunity to sell dollars and euros because nobody knows how long this stock rally will last," said Mitsuru Sahara, senior manager of forex trading at Bank of Tokyo-Mitsubishi UFJ.
Some Japanese institutional investors were also selling the dollar and other currencies as they shed some of their hefty foreign asset holdings and repatriate funds.
Trading in currencies remained very choppy due to the very poor liquidity plaguing many markets, as the severe bouts of volatility have prompted investors to shift to the sidelines until conditions calm down.
The euro dipped 0.3 percent to 124.01 yen but traded in a wide range between 127.40 yen and 123.60 yen.
But the euro edged up 0.4 percent to $1.2740 recovering from a 2-1/2-year low of $1.2335 struck the previous day. (Additional reporting by Rika Otsuka; Editing by Michael Watson)