(Correcting 11th paragraph to show that the data came out on Tuesday not Wednesday)
* Aussie down 0.4 pct, extends Tuesday's losses
* Dollar shrugs off weak U.S. data, focus on Yellen
* Investors also eyeing euro zone inflation on Friday
By Laurence Fletcher and Joshua Franklin
LONDON, Feb 26 (Reuters) - The Australian dollar fell on Wednesday as a continuing slide in the Chinese yuan highlighted concerns about a slowdown in Australia's top export market, while the U.S. dollar edged higher ahead of testimony by Federal Reserve Chair Janet Yellen.
The Australian dollar dropped 0.4 percent to $0.8982 , heading back towards a three-and-a-half-year low of $0.8660 hit last month.
The fall comes after a slide in the yuan in recent days, which many commentators suspect was engineered by the People's Bank of China to help soften a slowdown in the Chinese economy, with signs this week of a cooling of property prices.
"Concerns about Chinese growth (and) weaker commodities prices certainly mean that the Australian dollar is still quite vulnerable," said Jane Foley, senior currency strategist at Rabobank.
While the Aussie has been a large short bet for hedge funds in recent years, there are signs of that tempering after the Reserve Bank of Australia this month dropped its bias towards easing policy.
"The market no longer appears to be dominated with one-way bearish sentiment when it comes to the Aussie dollar. That said, the Aussie remains very sensitive to Chinese data," said Rabobank's Foley.
The euro, which a week ago hit its highest level against the dollar since Jan. 2, was 0.1 percent lower at $1.3727. The dollar index was marginally higher at 80.168.
Overall, trading was thin, with traders pointing to large option expiries and hedge funds cutting back positions as keeping major currencies in tight ranges.
Investors are looking ahead to euro zone inflation data on Friday, ahead of next week's European Central Bank meeting, and Yellen's testimony, when she is expected to be quizzed on what a spate of soft U.S. economic data means for Fed plans to cut back its huge bond-buying programme.
"If you look at the U.S., the data has been weak but that's mostly weather-related," said Peter Kinsella, strategist with Commerzbank in London, who said he expects little movement in euro-dollar.
The dollar was largely able to shrug off data on Tuesday showing lower consumer confidence and a fall in regional manufacturing, offsetting solid gains in home prices.
Against the yen the dollar was 0.1 percent higher at 102.35 yen.
"Most of the event risk is confined to next week," said Stephen Gallo, FX strategist at BMO Capital Markets.
"Macro and other funds have also had a horrible month again, so I think you have already seen a paring of risk positions into month-end, with little if any desire to put anything new on."
The Swedish crown initially fell to a day's low against the euro after Riksbank policymakers said lower interest rates could be needed.
The euro hit 8.9550 crowns per euro after the Swedish central bank's minutes raised the possibility of further cuts in the repo rate if a pick-up in inflation failed to materialise. But the crown later recovered, with the euro trading up only marginally at 8.9295 crowns.
While the surge in volatility in the Chinese yuan has so far had only a limited impact on developed market currencies, investors are watching the Aussie dollar and other currencies closely related to Chinese growth for signs of that changing.
The dollar was last at 6.1248 yuan, compared with levels closer to 6.0600 just a week ago.
Spot yuan has entered a dramatic weakening cycle in recent weeks, guided downward by a series of weak fixings by the central bank, with additional momentum added to the slide by the unwinding of yuan positions by Chinese banks.
Many market watchers see the move as a prelude to a widening of the yuan's trading band and believe the currency's longer-term uptrend remains intact, despite recent data showing the world's second-biggest economy is losing steam.
"Chinese macro economic risk is a factor capping the dollar against the yen," said Shusuke Yamada, chief Japan currency strategist at Merrill Lynch Japan Securities.
"Macro economic risks from the U.S., China and Japan have grown significantly. That said, such risks are unlikely to fully materialise until key data releases in April, and the dollar is likely to be rangebound until then," Yamada said. (Additional reporting by Ian Chua in Sydney; Editing by Susan Fenton)