* Dollar trims gains made in knee-jerk reaction to China easing
* Shanghai stocks' performance later in session eyed for direction
* Euro, yen seen continuing to gain from risk aversion longer term
By Shinichi Saoshiro
TOKYO, Aug 26 (Reuters) - The dollar edged down against the euro and yen on Wednesday as sentiment remained shaky even after China embarked on much-anticipated policy easing steps.
The U.S. currency was down 0.1 percent at 118.79 yen JPY= . It rose as high as 120.40 overnight, pulling away from a seven-month low of 116.15, after China's central bank cut interest rates for the second time in two months late on Tuesday.
The greenback traded above 125 yen less than two weeks ago, before wide-spread risk aversion prompted investors to buy back the yen and euro - currencies used to fund investments into riskier assets in so-called 'carry trades'.
The euro rose 0.2 percent to $1.1542 EUR= , after losing 0.9 percent overnight to move away from its seven-month peak of $1.1715.
Investors were focused on how Chinese stock markets would react after the People's Bank of China (PBOC) cut the one-year benchmark bank lending rate by 25 basis points to 4.6 percent, and reduced reserve requirements (RRR) by 50 basis points to 18 percent for most big banks.
The steps, which many had expected the PBOC to roll out last weekend, came after an accelerated freefall in Chinese shares triggered a world-wide domino effect on equities and commodities.
"The dollar did manage to gain a breather after the PBOC's announcement, but whether Shanghai stocks can actually draw support from these measures today is likely to determine its direction," said Junichi Ishikawa, market analyst at IG Securities in Tokyo.
"We have seen the yen and particularly euro gain on flight from risk which results in unwinding of carry trades. The euro has developed a reverse correlation with equities, particularly after the rout in China. Given its ample liquidity, it will likely continue to gain in times of 'risk off,'" Ishikawa said.
In a sign that sentiment remained fragile despite the PBOC's rate cuts, initial Wall Street gains evaporated on Tuesady and U.S. stock index futures ESc1 fell about 1 percent in early Asian trade on Wednesday.
The Australian dollar, used as a liquid China proxy, was down 0.3 percent at $0.7113. The decline nudged the Aussie back towards a 6-1/2-year low of $0.7044 struck on Monday.
The dollar index .DXY was down 0.2 percent at 93.738 after gaining 0.7 percent on Tuesday. (Editing by Kim Coghill)