Toyota Motor Corp <7203.T> said its annual loss would be smaller than earlier forecast thanks to deeper cost cuts and government measures to jump-start sluggish global auto demand, but remained cautious on the prospects for a sustainable recovery.

Toyota, the world's biggest automaker, slipped to its third straight quarterly loss as sales sank by double-digits in Japan, Europe and the United States due to mounting job losses, tight access to credit and volatile fuel prices.

But production is gradually picking up in Japan, most notably to assemble more of the Prius hybrid car, for which customers in Japan are waiting at least eight months for delivery.

Toyota raised its forecasts for global vehicle sales by 100,000 vehicles to 6.6 million, solely on the back of expected sales in Japan, where it has benefited from incentives and tax breaks on more fuel efficient vehicles.

A similar scheme introduced in the United States helped limit Toyota's U.S. sales drop to 11 percent last month.

Analysts cautioned, however, that such stimulus efforts could prove temporary and noted that Toyota's new forecast for a 750 billion yen ($7.86 billion) operating loss was still pessimistic.

The first-quarter results were slightly better than expected. But the company's forecast had been conservative and there had been expectations following the good results by Honda and Nissan, so there is no surprise, said Kazuyuki Terao, chief investment officer at RCM Japan, in Tokyo

Last week, domestic rivals Honda Motor Co <7267.T> and Nissan Motor Co <7201.T> surprised with a first-quarter profit, which they attributed to deeper-than-anticipated cost reductions.

MORE COST CUTTING

In the April-June quarter, which saw two U.S. automakers succumb to bankruptcy, Toyota made an operating loss of 194.9 billion yen ($2.04 billion). That compared with a profit of 412.6 billion yen a year earlier and a consensus loss estimate of 326 billion yen in a survey of five analysts polled by Thomson Reuters.

Toyota lost a net 77.8 billion yen, swinging from a profit of 353.7 billion yen in the first quarter a year ago. Revenue declined 38 percent to 3.84 trillion yen.

Toyota raised its cost savings target to 900 billion yen from 800 billion yen, through steps such as accelerating measures to eliminate quality-related costs and cutting labor costs through work-sharing.

For the year to March 31, 2010, the maker of the Corolla and Tundra forecast an operating loss of 750 billion yen and net loss of 450 billion yen, better than its projections three months ago for a losses of 850 billion yen and 550 billion yen, respectively.

A survey of 22 analysts by Thomson Reuters put the operating loss forecast at a much better 467 billion yen loss, prompting analysts to suggest further upgrades in forecast could follow.

The company remained cautious.

Demand is being supported to a large extent by government schemes, and it's difficult to get a read on how much this will translate into a fundamental recovery in demand, Senior Managing Director Takahiko Ijichi told a news conference.

Profitability could improve in North America, where Toyota is preparing to dissolve a loss-making plant in California that it ran with General Motors before the U.S. automaker left it behind in bankruptcy with Motors Liquidation Co .

A liquidation would likely result in a one-off loss, but it would help Toyota in the long run by raising the rate of capacity utilization at its other North American factories, analysts said.

Shares of Toyota have gained 37 percent in the year to date, against a 17 percent rise in the benchmark Nikkei average <.N225>.

Before the results were announced, Toyota ended down 1.5 percent versus a 1.9 percent fall in the transport equipment index <.ITEQP.T>

(Editing by Lincoln Feast)

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