JGB 10-year yield near 3-month low on econ worries

* JGBs inch up despite fall in Treasuries, Nikkei rise

* Industrial output highlights economic weakness

* Investors seen looking to buy before yields enter downtrend

* Steady BOJ rate outlook limits scope for yield declines

By Chikako Mogi

TOKYO, July 30 (Reuters) - The key Japanese government bond yield held near a three-month low on Wednesday as weak industrial production data reinforced worries about the economic outlook.

Japan's industrial output fell 2.0 percent in June from May, below the median market forecast of a 1.7 percent decline.

Manufacturers' output, the core component of production, is expected to fall 0.2 percent in July and decrease 0.6 percent in August, government data showed. [JP/IP1]

Bond gains were limited, however, as many players stayed on the sidelines, waiting for U.S. jobs data due on Friday and the Federal Reserve's policy meeting next Tuesday for clues on the market's direction.

Developments in the U.S. Treasuries market, U.S. stock market and follow-through reaction in Japanese equities have been driving the JGB market in recent weeks.

Investors were caught in a quandary, analysts said. As more signs of a weakening economy emerge, investors want to buy bonds before yields start to decline on deepening growth worries. But depending on overseas market developments and stock market performances, yields could still rise, and this is preventing investors from buying early.

"More and more investors are finding themselves in a dilemma, unsure how to time their bond buying," said Mari Iwashita, senior market economist at Daiwa Securities SMBC.

"They don't want yields to fall just yet and are hoping for yields to climb so they can buy before growth worries accelerate buying momentum and put downward pressure on yields. This is keeping the market in ranges."

Wednesday's bond prices were also capped by solid Tokyo share prices, which at one point rose 1.6 percent. The Nikkei stock average .N225 ended the morning session up 1.19 percent.

September 10-year JGB futures edged up 0.04 point to 136.27 2JGBv1 in thin trading volume of some 9,000 contracts.

The 10-year JGB yield was unchanged at 1.540 percent JP10YTN=JBTC, after easing to 1.535 percent in early trade, closer to a three-month low of 1.525 percent hit on Tuesday.

The five-year yield JP5YTN=JBTC and the two-year yield JP2YTN=JBTC were both flat on the day at 1.115 percent and 0.795 percent, respectively.

Traders said the likelihood that the Bank of Japan will keep interest rates steady at 0.5 percent was making investors cautious about buying JGBs aggressively near current levels.

"There is no fresh evidence to support the view that the market is facing a turning point. So players continue to take their cue from the weakening Japanese economy, rising consumer prices and fragile credit markets while wondering what to make of the steady BOJ rate outlook," said a senior dealer at a big Japanese bank.

He expected the five-year yield to trade in a 1.1-1.3 percent range and the 10-year yield in a 1.5-1.6 percent band for now.

U.S. Treasuries fell on Tuesday after a modest uptick in consumer confidence in July, which pushed the gauge slightly away from a 16-year low set in June, and as falling oil boosted stocks and eroded Treasuries' safe-haven appeal.

Lower energy costs and the slightly less gloomy mood among consumers brightened the economic outlook and supported the view the Fed might raise interest rates later this year to fight inflation, analysts said.

(Editing by Sophie Hardach)