* Yen recovers after biggest drop vs dollar since 1974
* Nikkei up 7 pct on news BOJ may cut rates this week
* Japan exporters, investors sell into dollar's rebound
By Eric Burroughs
TOKYO, Oct 29 (Reuters) - The yen climbed on Wednesday after suffering one of its biggest ever drops against the dollar the previous day, with market players saying the slide on Bank of Japan rate cut expectations and rebounding stocks had gone too far.
Reports the Bank of Japan could cut interest rates this week sparked a hefty stock market rally and a recovery in investors' appetite for risk. But financial markets remained very volatile, with the Nikkei share average moving in a wide range before ending up 7.7 percent.
Japan's central bank is considering cutting rates from the already low 0.5 percent at Friday's policy meeting, a source told Reuters, just as the Federal Reserve is expected to slash rates later in the day 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 an 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.
"The yen is expected to stay strong for a while because these are not conditions in which market players, including hedge funds, will resume the yen carry trades yet. But the excessive appreciation of the yen seems to have been halted," said Kazuyuki Kato, treasury department manager at Mizuho Trust & Banking.
Traders said the yen was now less likely to strengthen beyond the 90.87 yen peak against the dollar reached last Friday.
The yen's jump this month has compounded the slide in the Nikkei to a 26-year low as well as falls in other stock markets, creating a vicious circle that analysts see as a major factor behind this week's G7 response.
The dollar fell 1.1 percent from late U.S. trade to 96.94 yen after having surged as high as 99.79 yen on trading platform EBS, well above the 13-year low of 90.87 yen struck last week.
On Tuesday the dollar soared more than 6 percent against the yen -- the biggest one-day gain since 1974 and the second-biggest since being allowed to trade freely in 1973, according to data from Reuters Ecowin.
The euro slipped 0.6 percent to 123.55 yen pulling back from an early high of 127.30 yen but well above the 6-½ year low of 113.62 yen hit on Monday.
The iBoxx trade-weighted index for the yen has soared about 15 percent this month on the heavy selling of the euro, Australian dollar and even emerging market currencies for the Japanese currency.
The euro rose 0.4 percent to $1.2740 It hit a 2-½ year low of $1.2329 on EBS the previous day.
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, a 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.
"It's not fundamentals driving things. It's just pain," said a forex trader at a U.S. bank in Hong Kong.
Trading in currencies remained very choppy due to the poor liquidity plaguing many markets, as the severe bouts of volatility have prompted a variety of investors to shift to the sidelines until conditions calm down. (Additional reporting by Rika Otsuka and Kaori Kaneko; Editing by Michael Watson)