TOKYO, Feb 28 The yen fell against the dollar on Wednesday, taking a breather after surgi

TOKYO, Feb 28 (Reuters) The yen fell against the dollar on Wednesday, taking a breather after surging to 10-week highs in the previous session as investors unwound risky trades on fears of rising volatility in financial markets.

A tumble in global stocks, including the biggest daily fall in Chinese share prices in a decade, soft U.S. economic data and growing tensions over Iran's nuclear programme prompted investors to cut their risk exposure on Tuesday.

A wide variety of investors have used the low-yielding yen as a cheap source of funds to buy higher-yielding currencies and assets in carry trade, driving the Japanese currency to an all-time low against the euro last week.

Traders said the violence of Tuesday's yen moves -- a surge of 2 percent against the dollar for its biggest one-day jump in 14 months -- may mean more market players have to reverse positions in which they bet the yen would stay weak.

''I think we're on the edge of quite a large move,'' said Luke Waddington, head of FX trading at Royal Bank of Scotland in Tokyo.

The dollar gained some reprieve against the yen on Wednesday, however, buoyed by active dollar buying by Japanese importers and Japanese retail investors using currency margin trading, traders said.

The U.S. currency rose to an intraday high of 118.73 yen before pulling back to around 118.40 yen up 0.4 percent on the day. On Tuesday the dollar fell as low as 117.50 yen, the lowest since Dec.

15.

The yen had surged across the board on Tuesday, rising sharply against currencies such as the euro, sterling, and the Australian and New Zealand dollars.

''To put it simply, it was position adjustment of an intense nature,'' said Shuichi Kanehira, senior vice president at Mizuho Corporate Bank.

Low volatility and Japan's rock-bottom interest rates had contributed to the popularity of yen carry trades.

The Bank of Japan raised interest rates to 0.50 percent a week ago but the yen has been dogged by expectations that the BOJ will take time before raising rates again.

RISK REDUCTION The euro climbed to 156.45 yen up from around 156.20 yen in late U.S. trading on Tuesday.

The single European currency fell 0.2 percent to $1.3215 pulling away from a two-month high of $1.3260 hit in the previous session.

Despite the yen's retreat on Wednesday, market players said it was unclear whether the bout of short-covering in the Japanese currency was over.

''I think equities markets will remain unstable for a while,'' said Masafumi Yamamoto, a currency strategist at Nikko Citigroup, adding that rises in volatility would make it difficult to conduct yen carry trades.

Others said the overall trend to sell the yen due to its low yield remained intact, and the dollar was unlikely to stray far from the 118-122 yen range it has been hemmed in for the past few months.

China's benchmark Shanghai Composite Index, whose 9 percent plunge on Tuesday sparked a rout in equity markets around the world, gained 1.4 percent. But Tokyo's Nikkei average shed more than 3 percent.

One of the factors that hurt the dollar on Tuesday was a report showing an unexpectedly sharp drop in U.S. durable goods orders in January, adding to speculation the Federal Reserve may cut interest rates later this year to prop up a slowing economy.

Given speculation about the Fed's rate outlook, market participants were anticipating data on fourth-quarter growth as well as new home sales for January due later in the session.

REUTERS CS ND1202