Asian stocks rose on Monday as investors counted on the start of the U.S. earnings season this week to show firms were reaping strong profits and that the world's economic recovery was not losing steam.

Investors largely shrugged off the chance that Japan, the world's No. 2 economy, may be trapped in a policy gridlock after the ruling government lost a key poll on Sunday. Both the yen and Tokyo's Nikkei average <.N225> dipped, but investors said the election result was largely priced in and would have only a limited impact.

The MSCI index of Asia-Pacific stocks outside Japan <.MIAPJ0000PUS> rose 0.3 percent, adding on to its 4.8 percent gain last week. That had been its best week in over seven months.

Financial bookmakers expected European shares to be buoyant as well, with stocks in Britain <.FTSE>, Germany <.GDAXI> and France <.FCHI> seen rising 0.5 to 0.6 percent.

U.S. earnings will be reasonably strong, but the key question is can consumer demand be strong enough to keep earnings growth sustainable? said Mark Konyn, who oversees about $11 billion as Asia-Pacific chief executive of RCM in Hong Kong.

Indeed, ThomsonReuters data suggested upcoming U.S. corporate results should have a decent showing.

Earnings on the S&P 500 are seen to have grown 27 percent in the second quarter. That is up from previous readings in the past three quarters, which hovered around 22 percent. <.N/O>

But the outlook for U.S. consumer demand is less bright. U.S. retail sales data out on Wednesday is expected to show spending easing 0.2 percent in June.

Sluggish U.S. economic activity contrasts sharply with that in China, where trade data showed over the weekend that the world's No. 3 economy was growing rapidly, with exports surging 44 percent in June from a ago.

But even with China's economy charging forward, there is no missing investor anxiety that the world economy may still be on

shaky ground.

For the year, the MSCI Asia-Pacific ex-Japan stock index has shed 4.7 percent, with the bulk of heavy selling done in May during the throes of Greece's debt crisis.

In contrast, the HSBC Asia dollar bond index is up 6.2 percent for the year, indicating investors preferred buying safe-haven assets.

Data from fund tracker EPFR showed a similar trend. Over $11 billion of net outflows were drained from global equity funds in the first week of July. Money market funds, which are deemed to be safer, had the biggest inflows in 18 months.

Oil was down 0.5 percent at $75.69, having hit a near two week high on Friday, while gold prices dipped but still held above $1,200 an ounce.

POLICY GRIDLOCK?

In Japan, the Nikkei stock index vacillated between gains and losses on Monday. Yet moves either way were modest, suggesting investors were not particularly worried about the government's latest setback.

Japan's ruling coalition government, under Prime Minister Naoto Kan, had lost an upper house election on Sunday that could prevent it from passing laws smoothly in future.

With Japan already saddled with one of the world's largest public debts by proportion of its economy, many analysts had said Sunday's loss threatens Kan's job and puts into doubt the government's ability to urgently cut debt.

It's political paralysis, said Gerry Curtis, a professor at Columbia University. Kan is not going to quit and it's going to be very difficult to govern.

By the close, the Nikkei average was down 0.4 percent, having risen as much as 0.5 percent during the day.

The yen eased a touch but even traders said the move was likely to be short-lived because the market was more focused on the impending U.S. earnings season.

The dollar rose 0.3 percent against the softer yen to 88.90 yen . Japanese government bond yields, defying expectations for a rise, edged lower.

The market appears to have priced in the government losing its majority beforehand, said Atsushi Ito, a fixed-income strategist at Morgan Stanley MUFG in Tokyo.

But it still remains to be seen how the market digests policy implications going forward.

Selling pressure seemed modest, especially in light of the yen and Nikkei's recent strong performances.

The yen had rallied to seven-month highs against the dollar on July 1, while the Nikkei had just managed its best performance in about seven months last week.

(Reporting by Koh Gui Qing and Tokyo Newsroom; Editing by Lincoln Feast)

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