* Nikkei pares gains but still up 4% on Microsoft ( MSFT )-inspired

chip share rally

* BOJ signals readiness to tighten policy further, flags

risk of inflation overshoot

* Yen retreat comes after surge on Thursday following

currency intervention

(Updates prices; adds bullets, analyst comments in paragraphs

5-6 and 16)

By Kevin Buckland

TOKYO, July 31 (Reuters) - The yen added to losses while

Japanese government bonds were off lows on Friday after the Bank

of Japan held interest rates steady, as widely predicted.

The Nikkei share average pared gains, but remained

around 4% higher as chip-related shares rallied in line with

gains on Wall Street overnight after Microsoft ( MSFT )

delivered forecasts that eased fears about the industry's

massive AI infrastructure spending.

The yen was 0.8% weaker at 160.70 per U.S. dollar as

of 0425 GMT, from around 160.58 before the BOJ's announcement,

which came when most other financial instruments were in the

midday trading recess.

On Thursday, the yen had surged as much as 3.6% from near a

four-decade low after Japanese authorities conducted the first

intervention in three months to prop up the ailing currency.

"If currency intervention was timed to coincide with the BOJ

meeting, it could be interpreted as a message that the

government does not want the BOJ to raise interest rates on the

grounds of yen depreciation," said Kazutaka Maeda, senior

economist at Meiji Yasuda Research Institute.

"That said, intervention only buys time. If the underlying

weak yen trend remains unchanged, discussion will naturally

return to further rate hikes."

The two-year JGB yield, which is the tenor

most sensitive to the central bank's policy, pared an earlier

1.5 basis point rise to be up 1 bp at 1.505%. Yields move

inversely to prices.

The 10-year yield shed a 0.5 bp advance to be

flat at 2.795%.

The Japanese central bank held the key rate at 1%, having

just raised it in June, while signalling its resolve to continue

pushing up borrowing costs, warning for the first time that

underlying inflation could exceed its target.

"I got the impression that the statement was somewhat

hawkish," said Masato Koike, senior economist at Sompo Institute

Plus. "The likelihood of an October hike has increased."

Over the remainder of this year, the BOJ has policy meetings

in September, October and December.

The Nikkei was up 4% at 64,365.61, after entering the midday

recess at 64,572.25. The broader Topix was 1.4% higher

on the day.

Chip-testing equipment manufacturer Advantest ( ADTTF )

soared 16% and AI-focused startup investor SoftBank Group

leapt 14.5%.

Overnight, the U.S. S&P 500 gained 1.7% and the

tech-heavy Nasdaq climbed 2.8%. Microsoft ( MSFT ) surged 15.5%

after forecasting quarterly sales and cloud growth above

expectations.

"It confirmed continued strong demand for AI," said Nomura

strategist Maki Sawada. "The U.S. rally is having a big impact

on Japanese shares today."

(Reporting by Kevin Buckland; Editing by Sonia Cheema and

Mrigank Dhaniwala)