TOKYO, July 1 (Reuters) - Japan's Nikkei share average

extended its rally into a third straight session on Wednesday,

supported by AI-related shares, although investor caution

amid market volatility capped gains.

The Nikkei rose 0.6% to 70,497.49 by lunchtime,

after gaining as much as 2.7% earlier. The broader Topix

climbed 0.4% to 4,010.68.

"Domestically, buying is likely to lead in chip-related

stocks, suggesting the market will open higher," analysts at

Tokai Tokyo Intelligence Laboratory said in a note. "That said,

the Nikkei average rose sharply at the open the previous day

before quickly losing momentum, so investors should remain wary

of short-term overheating and profit-taking."

AI-related shares that have underpinned the Nikkei's recent

rally remained firm. Capacitor and electronic parts maker Taiyo

Yuden ( TYOYF ) topped the blue-chip index with a 13.4% jump,

while Sumco ( SUMCF ), a leading supplier of silicon wafers for

semiconductors, gained 11.3%. Ibiden ( IBIDF ), a semiconductor

packaging and electronics firm, rose 9.8%.

Kawasaki Heavy Industries ( KWHIF ) shares were volatile,

briefly rising more than 5% before falling 7.4%, after Reuters

reported the company was finalising plans to raise about 200

billion yen ($1.23 billion) through new shares and convertible

bonds to fund capital expenditure.

Among decliners, department store and retail group J. Front

Retailing ( JFROF ) was the Nikkei's worst performer, dropping

10.8% after disappointing March-May earnings. Furukawa Electric ( FUWAF )

, a cables and components maker, lost 7.2%, while

Sapporo Breweries slipped 5.4%.

There were 90 advancers on the Nikkei index against 135

decliners.

Sentiment among big Japanese manufacturers improved in the

three months to June to levels unseen since 2018, the Bank of

Japan's Tankan survey showed on Wednesday. Still, companies

expect business conditions to worsen over the next three months

as they brace for rising costs and potential supply constraints

stemming from the Middle East conflict.

($1 = 162.6600 yen)