(For more stories on Japanese politics click [ID:nPOLJP])
* Main opposition party leader resigns to help party
* Scandal had eaten into opposition Democratic Party's lead
* Move to improve election chances, but not all damage undone
TOKYO, May 11 (Reuters) - Japanese opposition leader Ichiro Ozawa resigned on Monday in a move that is likely to improve his party's prospects in a looming election, after a fundraising scandal dampened its hopes for victory.
A political stalemate and voter frustrations with Prime Minister Taro Aso had raised the chances Ozawa would lead his Democratic Party to victory in an election that must be held by October, ending more than 50 years of nearly unbroken rule by Aso's Liberal Democratic Party (LDP).
But the Democratic Party's lead in polls has narrowed after the scandal, clouding the outlook for the solid opposition victory that would break a deadlock that is stalling policy decisions as Japan struggles with a deep recession. [ID:nT75082]
"I have decided to sacrifice myself and resign as party leader to strengthen the unity of the party towards a clear victory in the next election and achieve a change in government," Ozawa told a news conference.
The Democrats have vowed to reduce bureaucrats' meddling in policy-making, stress the rights of consumers and workers over corporate interests, and adopt a diplomatic policy less subservient to security ally the United States.
Those positions were unlikely to be altered by Ozawa's departure, although a rejuvenated opposition might encourage the LDP to come up with extra stimulus plans to attract voters.
A 15 trillion yen ($153 billion) spending package is already on its way through parliament. [ID:nT56332]
Ozawa's resignation had little impact on financial markets, with the yen JPY= trading a touch lower after an initial media report, but broadly unchanged on the day. FXNEWS [FRX/]
Aso, who has threatened to call an early election if the Democrats obstruct debate in parliament on the massive extra budget to fight the recession, told reporters Ozawa's resignation would have no direct impact on the election timing.
Recent speculation has focused on an August vote.
"Now that (Ozawa) is gone, Prime Minister Aso might become more aggressive in economic stimulus to woo voters, rather than dissolving parliament now," said Hidenori Suezawa, chief strategist at Daiwa Securities SMBC.
While replacing Ozawa is likely to improve the Democrats' chances at the polls, not all the damage will be so easily undone, analysts said. [ID:nT53405]
"Things had gotten very tough. People were complaining about Ozawa," said independent political commentator Minoru Morita. "This improves the outlook for the Democrats quite a lot."
Ozawa's exit could open the way for a younger leader, with possible candidates including former party leaders Katsuya Okada, an advocate of tougher climate policies seen as the frontrunner, and Seiji Maehara, a conservative security policy expert.
Two other ex-leaders who are Ozawa's deputies, Yukio Hatoyama and Naoto Kan, are also possible successors. [ID:nT56552]
Ozawa, a skilled campaign strategist, has been shaking up Japanese politics for almost two decades since bolting the LDP and helping to briefly replace it with a pro-reform coalition.
How far his resignation improves the Democrats' chances depends at least in part on who replaces him, and how smoothly.
"It is a necessary step toward fixing the image problem. Now the question is whom do they chose, how do they chose him and how does he perform," said Gerry Curtis, a Columbia University professor and expert in Japanese politics.
A Democratic Party source said the next leader would likely be chosen by a vote among party lawmakers, possibly within a week or 10 days.
A survey by the daily Yomiuri newspaper before Ozawa's announcement and published on Monday showed the Democrats still had a razor-thin lead over the LDP, but that more than two-thirds of respondents questioned his earlier decision to stay on.
"If Ozawa had stayed, I was going to submit a blank paper when I cast my vote," said Yukihiro Nakagawa, 44, an executive at a precision machinery company. "I would like to make up my mind after seeing what kind of policies the Democrats will promise after this, but I am leaning towards voting for the Democrats."
(For a graphic showing the trend in Japanese polls, click:
The poll by the Yomiuri newspaper conducted before Ozawa's announcement showed 30 percent of respondents would vote for the Democrats in the next election against 27 percent for the LDP.
Some experts have said Ozawa's resignation would revive calls in the LDP to replace the unpopular Aso, but others said there is no obvious successor and Aso would do his best to hang on. (Additional reporting by Isabel Reynolds, Yoko Nishikawa, Yoko Kubota, Writing by Linda Sieg, Editing by Dean Yates)