* Dollar takes breather after surging on China rate rise
* Euro up, Aussie rebounds 1 percent
* Sterling drops after BoE minutes
(Updates prices, adds quote, sterling reaction)
By Anirban Nag
LONDON, Oct 20 (Reuters) - The dollar fell against a basket of currencies for the first time in four sessions on Wednesday, as appetite for higher-yielding currencies stabilised after being jolted by a surprise interest rate hike by China.
The dollar index eased 0.6 percent to 77.737 .DXY =USD after climbing more than 1.6 percent the previous day and well above an 10-month low of 76.16, struck last week.
Analysts said the market's reaction to the previous day's move by China was overblown, and with the Federal Reserve set to ease monetary policy further next month any dollar rebound would be short-lived.
"I think the move itself indicated how excessive positioning in the market was, but any correction in the dollar will be short and shallow," said Derek Halpenny, European Head of Global Currency Research at BTM-UFJ. "The main driver will be QE from the Fed and that should weigh on the dollar."
Investors had increased their bets against the dollar in recent weeks and had gone long on currencies like the euro and the Australian dollar on heightened expectations the Federal Reserve will unveil a second round of quantitative easing.
Those stretched positions had increased chances of a short-covering bounce in the dollar.
"The dollar's move down through September went too far and was overdone. This bounce we saw is part of a healthy correction," said Jane Foley, senior currency strategist at Rabobank.
"The dollar's weakening trend remains intact, as China's rate hike will not be slowing down its economy significantly and this is just a temporary pause in 'risk-on' trades."
The U.S. currency is often seen as a safe-haven currency and gains when appetite for riskier assets or growth-linked currencies suffers.
ON TRACK FOR QE
Several Federal Reserve officials indicated on Tuesday that the central bank will soon offer further monetary stimulus, with one saying $100 billion a month in bond buying may be appropriate. [ID:nN19258951].
In the UK too, minutes from the Bank of England's last monetary policy committee meeting showed a three-way split, with one member voting for QE. [ID:nBOE004351]
That saw sterling fall to the day's low against the euro and give up some of its gains against the dollar. The euro was up 0.5 percent at 87.86 pence EURGBP=D4 while the pound was flat at $1.5727, falling from around $1.5740 before the minutes were released.
Sterling now awaits a spending cuts programme from the coalition government which many analysts say could hurt growth and prompt the BOE to keep monetary policy easy.
The euro was up 0.1 for the day at $1.3826 EUR=, steadying from its 1.6 percent slide the previous day. It had fallen sharply as investors trimmed some of their risk-taking positions after China raised interest rates by 25 basis points, its first such action in nearly three years.
The move spurred concerns that it could mark the start of a more aggressive phase of monetary tightening, dampening Chinese and global growth and denting China's voracious demand for commodities. [ID:nSGE69I0HU].
The euro also gained against the yen EURJPY=R, drawing some support from higher Chinese shares .SSEC.
But the dollar dipped 0.5 percent to 81.19 JPY=, not far from its 15-year low of 80.88 yen.
The higher-yielding Australian dollar rose 1 percent to a session high of $0.9790 AUD=D4 regaining some ground after sliding more than 2 percent on Tuesday. (Editing by Catherine Evans)