* Yen, dollar gain on rising risk aversion
* July 8-10 G8 meeting eyed for FX diversification debate
* U.S. June ISM shrinks at slower pace
(Recasts, adds comment, updates prices)
By Nick Olivari
NEW YORK, July 6 (Reuters) - The yen and the U.S. dollar gained broadly on Monday as investors, worried over the global economy's outlook, shunned risk and bought currencies perceived to be safe.
Data showing the U.S. service sector shrank at a slower pace in June from May failed to dent the overall market trend on the day.
But the upcoming G8 meeting and the possibility that it will feature a discussion about diminishing the dollar's role as the world's reserve currency could add to volatility.
Currencies including the Australian dollar and sterling, which have tended to benefit the most from any signs the global economy is on the mend, fell sharply as the fallout from grim U.S. jobs data last week continued.
Analysts said traders were coming to terms with signs recent economic data have not been consistently better than expected as in past months, and that it was possible for future readings to show weakness.
"People are re-assessing their views of the economy here and abroad," said John McCarthy, director of foreign exchange at ING Capital Markets in New York. "Risk aversion is the driving force."
Midway through the New York session, the dollar index, which tracks its performance against a basket of six major currencies, was up 0.1 percent on the day at 80.552. A fall in U.S. and European shares helped boost the U.S. currency.
The euro fell 0.3 percent to $1.3927, its lowest in nearly two weeks EUR=>, according to Reuters data. Also prompting euro weakness was a survey showing an unexpected worsening in euro zone Sentix index, which tracks investor and analyst sentiment.
The yen was the biggest beneficiary of increasing aversion to risk, pushing the dollar down 1.3 percent to 94.76 yen on electronic trading platform EBS, around a one-month low.
The Japanese currency also rallied on the crosses, pushing the euro down 1.5 percent to 132.27 yen, its weakest in nearly two weeks, while sterling fell roughly 1.9 percent to 153.60 yen, its weakest since late May.
Sterling, which is often seen as higher risk, fell 0.7 percent versus the dollar to $1.6225, according to Reuters data. Earlier it fell to a one-month low of 1.6095.
The Australian dollar lost 0.8 percent to $0.7907.
G8 SUMMIT IN FOCUS
This week also sees central bank policy decisions in Australia and Britain, while in the United States major companies begin to report earnings for the second quarter.
But the principal focus is the Group of Eight summit on July 8-10, with investors watching for the possibility of a debate on an alternative to the dollar as a world reserve currency.
Though any diversification of central bank reserves away from the dollar would take several years to materialize, investors are jittery about what comments may be made at this week's G8 meeting, particularly by China.
Analysts said they did not expect serious concerns to be raised about the issue this week, but some said the dollar's short-term vulnerability to comments about reserves suggested improving global fundamentals in the future may open the door to dollar weakness.
"While it may be too early to sell USD, the fact that the discussion has become so public suggests that USD weakness would accompany a global recovery as confidence is restored in the medium and long term," Barclays analysts said in a note.
The dollar received some support by reassurances from China, which said at the weekend that the U.S. currency would remain dominant for "many years to come".
In comments published on Monday, however, Chinese officials said the financial crisis had laid bare defects in the dollar-led global economy and the world should look to displace the U.S. currency, even if it takes many years.
The debate remains front and center, with India's Foreign Secretary Shivshankar Menon saying on Monday, that India is willing to discuss proposals to replace the U.S. dollar as the global reserve currency.
"This would be one of the ideas which is on the table. There have been ideas expressed, and we are ready to discuss all of them," Menon told reporters when asked if India would consider replacing the dollar. (Additional reporting by Steven C Johnson in New York and Naomi Tajitsu in London; Editing by Kenneth Barry)