Japan's Nikkei stock average edged higher Monday to build on last week's hefty gains on improved sentiment about the European debt situation, but uncertainty about how markets will assess Italy's new austerity plan capped the upside.

Italy's Cabinet approved a package of tax hikes, pension reforms and incentives to boost growth Sunday. Prime Minister Mario Monti will present the 30 billion euro plan to Parliament Monday.

On the face of it, the Italy news doesn't seem bad for markets, but Japanese investors need to see the reaction of European and U.S. markets to the plan before they can confirm that it's good news, said Masayoshi Okamoto, head of dealing at Jujiya Securities.

The 30 billion euro amount, is it too much, too little, or just right? We need to see what the market thinks of it, he added.

Key European events later this week remained in focus as well.

On Thursday, the European Central Bank will hold a regular policy meeting and is expected to cut interest rates. European Union leaders will also meet on Thursday and Friday, to seek agreement on a convincing rescue plan.

The Nikkei <.N225> rose 0.4 percent to 8,680.78 by the midday break, adding to its 6 percent gain last week. The broader Topix <.TOPX> added 0.4 percent to 747.12.

Volume was relatively thin, with 736 million shares changing hands so far, compared with last week's average full-day volume of 1.65 billion shares.

FINANCIALS OUTPERFORM

Strategists said one positive technical sign for the Nikkei is that it is now trading above its 25-day moving average, at 8,563.

The index also briefly broke above 8,700 for the first time in nearly a month, reaching an intraday high of 8,704.48 shortly after the open.

The Nikkei's recovery from recent lows is hopeful, but macroeconomic factors such as developments in Europe as well as China's economic outlook are also key for the direction of Japanese stocks, said Kenichi Hirano, operating officer at Tachibana Securities.

Japanese financial stocks outperformed the broader market. The banking subindex <.IBNKS.T> rose 1.8 percent, tracking U.S. financials, which were the biggest gainers on Friday boosted by a drop in the U.S. unemployment rate.

Sumitomo Mitsui Financial Group (8316.T) rose 2.7 percent to 2,222 yen and Mitsubishi UFJ Financial Group (8306.T) added 2.1 percent to 345 yen.

The securities subindex .ISECU.T gained 2.7 percent and was the top performing sector, as the market's overall rise raised hopes of higher earnings for brokerages. The subindex had lost 30 percent since July, but regained some ground, rising 10 percent since hitting a lifetime low on November 24.

Nomura Holdings Inc (8604.T) gained 3.5 percent to 264 yen and rival Daiwa Securities Group Inc (8601.T) rose 2 percent to 261 yen.

Olympus Corp (7733.T) added 1.1 percent to 1,079 yen. An investigative panel has found the firm hid up to $1.7 billion in losses from its investors, but is likely to say there is no evidence of involvement by organized crime in the cover-up, a source said on Monday.

Fast Retailing Co Ltd (9983.T) rose 3.7 percent to 12,950 yen after the operator of the Uniqlo clothing chain said on Friday domestic same-store sales in November fell 1 percent from a year earlier, an improvement from a 4 percent drop in October.

(Additional reporting by Mari Saito; Editing by Chris Gallagher)

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