Japanese business morale improved slightly in the three months to March, the Bank of Japan's closely watched tankan survey showed, but the devastating earthquake earlier this month and a subsequent nuclear crisis are seen hurting confidence in coming months.

Most of the replies came in before the magnitude 9.0 earthquake on March 11, which means the impact on business sentiment is not significantly reflected in the survey.

The BOJ will therefore release reference data for pre-quake and post-quake sentiment at 8:50 a.m. on Monday (2350 GMT Sunday).

KEY POINTS:

-- The headline index for big manufacturers' sentiment came in at plus 6 in March, up from plus 5 in December and compared with the median estimate of plus 7.

-- The index for June 2011 was seen at plus 2, showing that firms expect conditions to worsen.

-- Big firms plan to cut capital spending, a key driver of the economy, by 0.4 percent in the financial year to March 2012, against the median forecast for a 1.8 percent increase.

-- The tankan survey was compiled from February 24 to March 31, with 72 percent of the replies coming in before the March 11 quake.

COMMENTARY:

AZUSA KATO, ECONOMIST, BNP PARIBAS

The post-quake figures the BOJ will announce on Monday will be much more important. As today's reading includes both pre-quake and post-quake data, it does not have much value.

Having said that, the sentiment among both big manufacturers and non-manufacturers improved even though the data includes responses after the quake, which suggests that the economy was looking up before the earthquake.

Companies will have to curtail capital spending at least until summer because of bottlenecks from power shortages.

TAKESHI MINAMI, CHIEF ECONOMIST, NORINCHUKIN RESEARCH INSTITUTE

Today's data alone won't be of much use so the reference data next week was something that was needed. We're focusing on when companies see reconstruction demand picking up. But we can assume business conditions will be very severe ahead.

I don't think the BOJ will be able to directly underwrite government bonds. But instead, it can buy bonds from the market. If the government needs to issue, say, 5 trillion yen ($60 billion) in bonds for disaster relief, the BOJ can perhaps increase its bond purchases under its asset buying scheme by 2.5 trillion yen. It needs to do whatever it can do to support the economy.

AYAKO SERA, MARKET STRATEGIST, SUMITOMO TRUST & BANKING

Companies predict the dollar will average 84.20 yen this fiscal year, so the key is whether it rises above 85 yen amid the recent yen weakening trend. If the dollar averages above 85 yen, that would be a plus for exporters. On the other hand, a too-rapid and sharp weakening of the yen will deepen uncertainty for companies' business strategies.

As for the price index, more companies see a rise in input costs, so the increase in commodities prices, particularly energy prices, should be watched closely for their impact on corporate activities. But such a rise in prices could help bring Japan out of deflation, even if that is probably not how the BOJ wants to avoid deflation.

The quake will weigh on sentiment and it is difficult to gauge its impact now. Corporate capital investment plans will depend on how much of a drop there is in production due to damaged facilities and how much post-quake recovery demand there is.

The BOJ is not expected to take fresh measures next week, but rather, will assess the effect from steps taken at a previous meeting in March.

BACKGROUND:

-- The sentiment indexes are derived by subtracting the percentage of respondents who say conditions are poor from those who say they are good. A negative reading means pessimists outnumber optimists.

-- Economists expect Japan's economy to shrink in the April-June quarter in the aftermath of the deadly March 11 earthquake and tsunami, a Reuters poll taken last week showed, but most economists see a return to growth in the July-September quarter.

-- The government, which estimates material damage from the quake at about 16-25 trillion yen, aims to compile several emergency budgets to cope with the disaster, with the first likely due by the end of this month, focusing on urgent steps such as construction of temporary housing. ($1 = 83.160 Japanese Yen)

(Reporting by Rie Ishiguro, Leika Kihara and Hideyuki Sano; Editing by Edmund Klamann)

BNP Paribas Inflation Bank of Japan Japan