Nikkei scales 21-month high, heads for best yearly gain since 2005

A Tokyo Stock Exchange employee laughs as he works at the bourse in Tokyo December 17, 2012.

TOKYO (Reuters) - The Nikkei share average climbed 1.4 percent to a 21-month high on Thursday, led by exporters, as the new Japanese prime minister's vow to battle deflation and a strong currency weighed on the yen.

The Nikkei advanced 140.13 points to 10,370.49 by the midday break, rising for the third consecutive session and taking the index deeper into "overbought" territory, with its 14-day relative strength index at 78.5, far above 70 which is considered overbought and often indicates an imminent pullback.

The benchmark has risen 19.8 percent over the past six weeks, taking the year-to-date gain for the Nikkei to 22.7 percent, outpacing a 12.9 percent rise in the U.S. S&P 500 and a 14.7 percent gain in the pan-European STOXX Europe 600.

It is on track to log its best yearly gain since 2005.

"People are back in the office today...and putting on some positions based on what we saw after the cabinet appointment and LDP policy decision," a dealer at a foreign brokerage said, referring to the ruling party.

"It's going to be interesting to see what's going to happen in the market in the afternoon session and tomorrow because Tokyo closes pretty much for the entirety of next week. There is a lot of headline risk that could happen...I would not be surprised to see some profit-taking," the dealer said.

Finance Minister Taro Aso said Prime Minister Shinzo Abe has ordered him to compile a stimulus package without sticking to the previous government's cap on new bond issues, signalling a more aggressive policy to kick-start the ailing economy.

Exporters benefiting from the yen's weakness included Toyota Motor Corp (7203.T), Honda Motor Co (7267.T), TDK Corp (6762.T) and Panasonic Corp (6752.T), all up between 1.3 and 2.9 percent.

The yen hit a more than two-year low of 85.835 yen to the dollar. A weaker yen helps lift exporters' overseas earnings when repatriated, thereby improving their competitiveness, particularly against South Korean and Chinese rivals.

Helped by the yen weakness, the pace of deterioration in Japanese companies' earnings outlook has slowed further in December.

Their one-month earnings momentum - analysts' earnings upgrades minus downgrades as a total of estimates - stood at -7.2 percent, versus -10.9 percent in November and -12.2 percent in December.

Banks' one-month earnings momentum improved to 14 percent from 5.3 percent last month. The sector was up 1.7 percent on Thursday morning. Insurers also rose, up 1.7 percent, as the rally in stocks boosted the value of their equity holdings.

The broader Topix gained 1.3 percent to 858.86 in active trade on Thursday morning, with volume slightly above its full daily average of the past 90 trading days.

Japanese equities carry a 12-month forward price-to-earnings ratio of 12.6, slightly cheaper than the S&P 500's 12.8, but more expensive than STOXX Europe 600's 11.5, data from Thomson Reuters Datastream showed.

(Editing by Matt Driskill)