* 10-yr futures shed half a point, touches 3-month low
* 10-yr yield rises to 7-week high as Nikkei takes 10,000
* Yields may rise as economic pictures brighten
* Insurer demand expected at Thursday's 20-yr auction
By Lisa Twaronite
TOKYO, March 14 (Reuters) - Japanese government bond futures posted their biggest fall in a year on Wednesday and the 10-year cash bond yield rose to a seven-week high as equities rallied after the Federal Reserve took a brighter view of the U.S. economy.
Although further falls might be limited by how investors are expected to buy ahead of the end of Japan's fiscal year on March 31, many market players expect more pressure down the road if the U.S. and Japanese economies continue to recover.
Ten-year JGB futures closed down 0.54 point at 141.93 after touching 141.90, the lowest level in more than three months. It was the biggest fall since March 16 last year, when JGBs dropped as Japanese shares recovered from panic selling after the natural and nuclear disasters.
The yield on the latest 10-year JGB rose 3.5 basis points to a seven-week high of 1.005 percent.
"This is a short-term buying opportunity, expecting a short-term bounce before a bigger sell-off afterwards," said Neale Vincent, a strategist at Nomura Securities Co. in Tokyo.
"We think there will be strong dip-buying in the 1.0 percent to 1.1 percent range, then investors can be expected to back off and wait for around 1.25 percent. If yields were to break even higher than that, the next big round of buying probably won't kick in until around 1.40 to 1.45 percent," he said.
The benchmark Nikkei stock average closed above 10,000 for the first time in seven months on Wednesday, boosted by Wall Street gains on the Fed's upgraded U.S. economic outlook.
Tokyo shares received a further lift from a weaker yen, as a broadly firmer dollar rose to an 11-month high of 83.32 yen .
"Given the current situation, with the dollar/yen around 83 and the Nikkei around 10,000, a one-percent yield on the 10-year note looks low," said a fixed-income portfolio manager at a Japanese asset management company in Tokyo.
JGB futures have fallen about one percent, or 1.44 points, since spiking to 143.37 immediately after the BOJ's surprise easing announcement on Feb. 14.
That was their highest since November 2010, although many market players suspected at the time that the spike was caused by an unintended trade.
The 20-year yield rose 2.5 basis points to 1.775 percent even in the face of expected selling of that tenor ahead of Thursday's auction of 1.1 trillion yen of 20-year notes.
Market participants say they expect the sale to meet healthy demand from life insurers, and the results to be in line with other recent sales despite Wednesday's bearish market tone.
The 30-year tenor fared better than others on Wednesday, with its yield adding just a basis point and a half to 1.950 percent.
The JGB market is likely to be supported by expectations of further easing in coming months, as the BOJ is seen extending the maturity of bonds it buys under its asset purchase programme to three-year and five-year durations from its two-year parameter.
"The BOJ is keeping the window open for further easing action, extending its durations, maybe even increasing the amount of purchases for its operations," said Nomura's Vincent.
As widely expected, the BOJ on Tuesday maintained its key policy rate at a range of zero to 0.1 percent and also expanded a separate loan scheme targeting growth industries.
BOJ board member Ryuzo Miyao unsuccessfully proposed a further easing by increasing the bank's asset-buying and loan programme by 5 trillion yen ($61 billion), but that proposal was rejected by an 8-1 vote.
A working group for Japan's Ministry of Finance recommended that inflation-linked government bonds that the ministry is considering issuing should have a price floor and a maturity of 10 years, sources told Reuters.
Most financial institutions have told the ministry they can finish adjusting their trading systems to deal with new inflation-linked bonds within half a year, the sources said.