* FTSEurofirst 300 ends down 0.3 pct
* Fresh China rate rise adds to investor caution
* Peripheral lenders hard hit; ECB rate move eyed
By Simon Jessop
LONDON, July 6 (Reuters) - European shares snapped a seven-session winning streak on Wednesday after a Moody's downgrade of Portugal's sovereign credit to "junk" status fanned the flames of the euro zone debt crisis ahead of a regional interest rate-setting meeting.
The European Central Bank is expected to raise rates again to fight inflation, a move that will add to the peripherals' debt burden and follow hot on the heels of China, which on Wednesday raised rates for the third time this year.
A week after Greece passed key austerity votes and looked to have avoided a near-term default, kick-starting the equities rally, the Moody's and China moves pushed volatility up more than 3 percent, giving skittish investors a reason to take profits.
"Valuations suggest there could be a lot of upside, but they're fighting the macro shocks. So I think we do go up, but it will be a bumpy ride," Peter Sullivan, head of European and U.S. equity strategy at HSBC, said.
"Companies are earning returns on capital way above the cost of capital. In terms of delivering economic profit, they're having their best year in 20; in terms of being rewarded for that in valuations, it's probably their worst in 20."
The FTSEurofirst 300 index of leading European shares ended down 0.3 percent at 1,118.75 points, breaking its longest daily winning run since April but leaving the index on track to buck a two-month losing streak.
Banks, specifically Portuguese lenders and those exposed to the periphery, were hardest hit by Moody's four-notch ratings cut, released late Tuesday, with Millennium bcp down 6.9 percent, UniCredit off 7.1 percent and Credit Agricole 4.9 percent lower.
Those chunky declines added together to make the STOXX Europe 600 Banks index the top sectoral faller on the day, down 1.7 percent, while the Thomson Reuters Peripheral Eurozone Countries Index fell 2.9 percent.
That fresh flight from peripheral euro zone risk was also visible in traded volumes, with Portugal's PSI 20 seeing more than two and a half times its 90-day daily average and Italy's FTSE MIB 122 percent, against 86 percent for Germany's DAX .
For Societe Generale, the recent sell-off in Spanish equities, which continued on Wednesday with a fall of 1.2 percent for the blue-chip IBEX , was overdone.
It recommended switching out of the DAX , which has advanced 7.5 percent this year, in the short term.
Alexei Jourovski, head of equities at Swiss asset manager Unigestion, which has 3 billion euros ($4.4 billion)in assets under management using a low-risk "minimum variance" strategy, said he was bearish on financials in Greece, Portugal and Spain.
While stocks such as Santander and BBVA had attractive non-Spanish units, they and other Iberian banks had yet to adequately recapitalise and could face a tax hit from cash-strapped governments in Lisbon and Madrid, he said.
Jourovski expected volatility to increase following the end of the second round of U.S. quantitative easing, and this would likely benefit his funds as correlations break down and risk is re-priced.
"It's currently around 15 percent on most equity indices, but the historical average is around 25, so we have room for it to go up," he said.
Equity market volatility in Europe, as measured by the Euro STOXX 50 volatility index , rose 3.3 percent on Wednesday as investors bailed out of riskier assets such as equities.
The move by Beijing to raise rates, while not a surprise to many, nevertheless gave another reason to be cautious, said traders, citing concerns around global growth ahead of any bottoming in lead indicators.
With the ECB rate verdict and a similar decision by the Bank of England scheduled for Thursday's session, albeit with the latter expected to remain on hold, market caution is expected to remain into Friday and the next U.S. non-farm payrolls numbers.
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