* Euro pares loss on strong German data, stocks' rise
* Euro up 0.5 percent at $1.4044
* Sterling falls on weak UK factory orders
* Sentiment cautious; market wary of Q2 earnings
(Releads, adds comment, updates prices)
By Tamawa Desai
LONDON, July 7 (Reuters) - The euro pared early losses to trade higher against the dollar and yen on Tuesday after a larger-than-expected increase in German factory orders and as European share prices recovered.
But the euro's gains were tempered by underlying caution over the economic outlook, which had supported the dollar and yen earlier in the session. Markets were also wary ahead of U.S. corporate earnings due out later this week.
Sterling remained in negative territory against the dollar and euro as weaker-than-expected UK industrial production data reinforced doubts about an economic recovery.
By 1138 GMT, the euro was up 0.5 percent at $1.4044, near the day's high of $1.4050, after falling as low as $1.3904.
Data on Tuesday showed German manufacturing orders rose 4.4 percent on the month in May, sharply higher than forecasts for a 0.5 percent gain and the biggest rise since June 2007.
"The positive surprise from German figures may have helped push the EUR/USD a notch higher," said analysts at Calyon in a note.
The dollar index was down 0.3 percent at 80.143.
Meanwhile, sterling dipped to the day's low of $1.6152 after data showed manufacturing output fell 0.5 percent on the month in May, versus expectations of a 0.2 percent rise.
The wider industrial production measure also fell by 0.6 percent against forecasts of a 0.2 percent gain.
"The risk is clearly that the 'green shoots' are turning dry," said Michael Klawitter, senior currency strategist at Dresdner Kleinwort in Frankfurt.
The dollar was flat at 95.27 yen.
G8, EARNINGS
China, Russia and Brazil will use this week's Group of Eight leaders summit in Italy to push their view that the world needs to start seeking a new global reserve currency as an alternative to the dollar, officials said on Tuesday. But they also said that such a shift would take time.
U.S. President Barack Obama and Russian Prime Minister Vladimir Putin did not discuss oil prices or the dollar in Moscow on Tuesday, according to a U.S. official.
Top Kremlin economic aide Arkady Dvorkovich said the reserve currency debate "will not be discussed during G8". A draft of the communique obtained by Reuters made no reference to the issue.
Commodity-linked currencies such as the Australian and New Zealand dollar also retraced losses.
The Australian dollar was up 0.7 percent at $0.8028, recovering from a fall to $0.7935 after the Reserve Bank of Australia left interest rates at a record low 3.0 percent on Tuesday and left the door open to more easing.
Traders braced for second-quarter U.S. corporate earnings, which will be released in coming weeks. Analysts said poor results, especially from financial institutions, would likely crank up dollar demand.
"Traders may still be committed to the risk trade at the moment, but if bank earnings disappoint in any way or the S&P breaks crucial levels traders will probably start reducing long positions in (high-risk currencies) and the dollar could be bid more," said Chris Turner, currency strategist at ING in London. (Additional reporting by Naomi Tajitsu; Editing by Chris Pizzey/Victoria Main)