*

Auto stocks lead rally on reduced U.S. import levy; Toyota ( TM )

surges 14%

*

Bank shares gain as trade clarity bolsters case for BOJ

rate

hikes

*

Fiscal outlook in flux as prime minister denies reports

he's

stepping down

*

Benchmark JGB yields shoot to highest since 2008

(Updates prices, adds additional analyst comments)

By Kevin Buckland

TOKYO, July 23 (Reuters) - Japanese automakers led a

surge in the Nikkei share average to a one-year peak on

Wednesday, after Tokyo reached a trade deal with Washington,

ending a months-long stalemate.

Under the agreement, Japanese exports to the United States

face a 15% levy, down from a threatened tariff of 25%. Specific

duties on autos, which account for more than a quarter of

Japan's U.S. exports, also fell to 15% from 25%.

The Nikkei rallied 3.5% to end the day at 41,171.32,

its highest close since July last year.

The Tokyo Stock Exchange's transport equipment index

soared nearly 11%, with Toyota Motor ( TM ) surging

more than 14%.

The clarity on tariffs bolstered the case for the Bank of

Japan to resume raising interest rates, lifting short-term

Japanese government bond yields.

Longer-term JGB yields also climbed, with local media

reporting that embattled Prime Minister Shigeru Ishiba was

preparing to step down, suggesting a shift in the political

landscape towards increased fiscal largesse. Ishiba has denied

the reports.

The 10-year yield shot to the highest

since 2008 at 1.6%, while a 40-year debt auction garnered the

lowest demand since 2011.

The yen weakened about 0.3% to 147.02 per dollar

after initially flipping between gains and losses.

"As long as the political situation doesn't deteriorate too

much more, we suspect Japan's equity rally has further to run,"

Capital Economics head of Asia Pacific markets Thomas Mathews

wrote in a note.

For the rates market, "our sense is that investors are still

underestimating how fast the central bank will hike this year

and next," Mathews said.

Ishiba is facing growing opposition from within his Liberal

Democratic Party for his vow to stay in power despite the ruling

coalition's drubbing in Sunday's election, which resulted in the

loss of the coalition's upper house majority.

Opposition parties calling for debt-funded consumption tax

cuts made big gains at the polls.

The yield on 40-year JGBs climbed 8.5

basis points to hit 3.46%. Thirty-year yields

advanced as much as 6.5 basis points to 3.15%, approaching last

week's all-time high of 3.20%.

Two-year yields, which are more sensitive to

the monetary policy outlook, jumped 8 basis points to 0.83%, the

highest since April 2, when U.S. President Donald Trump shocked

markets with his aggressive "Liberation Day" tariff

announcement.

Expectations for tighter monetary policy also lifted the

TSE's banking index by 4.4%, making it the

second-biggest gainer among the bourse's 33 industry groupings.

The central bank will meet on policy next week.

BOJ Deputy Governor Shinichi Uchida said on Wednesday that

the trade deal greatly reduces uncertainty over the economic

outlook, but also warned that risks to activity and prices were

skewed to the downside.

"I don't think this (trade deal) alone will lead to a Bank

of Japan rate hike next week, but the possibility of a rate hike

between September and October has increased," said SMBC chief

currency strategist Hirofumi Suzuki.

"However, if anything, political uncertainty is having more

of an impact on the market, and the pressure for yen

depreciation is likely to continue."

(Reporting by Kevin Buckland; Editing by Himani Sarkar, Rashmi

Aich and Subhranshu Sahu)