* Yen drops, correcting sharp gains Wednesday; dlr also down
* Higher risk FX recover as European equities rise 1.2 percent * Focus on BoE decision at 1100 GMT
* Aussie gains but Australia-China rift casts a shadow
(Updates prices, adds quotes)
By Jessica Mortimer
LONDON, July 9 (Reuters) - The yen and the dollar fell on Thursday, correcting some of the previous session's gains, with a recovery in European stocks helping buoy the euro and perceived higher risk currencies.
European equities jumped by 1.2 percent, snapping a five-session losing streak after the U.S. second quarter corporate earnings season began with a smaller-than-expected loss from aluminium giant Alcoa Inc.
This helped lift sentiment and currencies reversed some of the sharp moves seen on Wednesday, when the yen jumped to a five-month high against the dollar as optimism about the global economy's recovery prospects waned and investors trimmed risk exposure.
Investors were cautious, however, ahead of a Bank of England policy meeting at 1100 GMT and the possibility that the central bank could expand its quantitative easing programme. They were also mindful that upcoming U.S. corporate earnings may disappoint.
"There is a better tone to equities and that has brought a short-term reversal in the move back towards risk aversion in the market," Rabobank currency analyst Jeremy Stretch said.
He noted, however, that the trend in the third quarter is still likely to be a bias towards risk aversion, which typically weighs on currencies seen as higher risk such as the Australian dollar and sterling to the benefit of the dollar and yen.
At 1009 GMT, the dollar rose 0.4 percent from late U.S. trade to 93.14 yen, having hit a five-month trough of 91.80 on EBS trading systems the previous day.
The euro climbed 1 percent to 130.16 yen after falling as low as 127.00 yen on Wednesday, its lowest since mid-May.
Against the dollar, the euro was up 0.7 percent at $1.3975 after falling as low as $1.3830 on Wednesday, while the dollar index fell 0.7 percent to 80.171.
The yen was also dented on Thursday after the previous day's sharp rise in the currency prompted Japanese officials to say excessive foreign exchange moves were undesirable and that they were watching movements closely.
In recent weeks, optimism about the global economy's recovery prospects has started to wane, prompting investors to trim holdings of riskier assets.
"It is true that investors are less optimistic, especially after last week's U.S. jobs data," said Tsutomu Soma, a senior manager of foreign securities at Okasan Securities in Tokyo.
"But even so, their views on the global economy are not as bad as recent abrupt moves in exchange rates might suggest."
BOE EYED
Analysts said investors took some encouragement as the International Monetary Fund raised its forecasts for world growth in 2010 and said the global economy is starting to pull out of a deep recession.
Among currencies seen as higher risk, sterling rose 0.8 percent against the dollar to $1.6199.
UK interest rates are seen remaining at a record low 0.5 percent, but market participants were nervous the bank may opt to expand its asset-buying plans.
Meanwhile, the Australian dollar recovered 0.9 percent to $0.7855, though analysts said the currency is highly sensitive to concerns about Australia's ties with its top trading partner China.
These concerns cast a further shadow against the currency on Wednesday, when it fell more than 1 percent against the dollar and 3.5 percent against the yen.
China confirmed on Thursday the arrest of an Australian mining executive and three others on spying allegations, in a case that has raised questions about China-Australia relations.
"If there were a freezing in the diplomatic temperature between Australia and China that would not be positive for the Australian dollar," Rabobank's Jeremy Stretch said. (Additional reporting by Rika Otsuka in Tokyo; Editing by Chris Pizzey)