JGBs erase losses on cautious credit outlook

* Nikkei trims gains, helps JGB futures rise

* Market cautious before U.S. reaction to Merrill earnings

* BOJ Governor Shirakawa to speak from 0330 GMT

By Satomi Noguchi

TOKYO, July 18 (Reuters) - Japanese government bonds edged up on Friday, erasing earlier losses made on Nikkei gains and after U.S. Treasuries fell the previous day on easing worry about the health of the U.S. bank sector.

Treasuries dropped on Thursday after J.P. Morgan (JPM.N) posted profit above Wall Street's expectations, which gave some hope that the credit crisis may not have pushed financial firms to the brink of disaster.

But JGBs regained ground as investors returned to the safe haven of government debt, fearing the impact of potentially disappointing after-hours earnings results from Merrill Lynch MER.N on U.S. markets later in the day, analysts said.

Investors were also hesitant to sell the bonds too aggressively before a long weekend. Japanese markets will be closed on Monday for a national holiday.

"The market may not be able to fully digest the impact of Merrill Lynch's earnings reports just yet," said Keiko Onogi, a senior JGB strategist at Daiwa Securities SMBC.

September futures 2JGBv1 rose 0.11 point to 136.51, recovering from earlier losses to 136.03 and stayed near a two-month high of 136.79 struck earlier this week.

The benchmark 10-year yield JP10YTN=JBTC edged down a basis point to 1.575 percent, in sight of a three-month low of 1.530 percent touched on Tuesday.

Merrill Lynch posted a much larger-than-expected $4.9 billion second-quarter loss on late Thursday after writing down soured debt, and said it is selling close to $8 billion of assets in a bid to raise fresh capital. [ID:nN17199614]

The Nikkei share average .N225 rose 0.4 percent by midday, but the stock market slipped back from an earlier 0.9 percent climb.[.T]

Bank of Japan Governor Masaaki Shirakawa will give a speech in Tokyo on the economy from 0330 GMT.

Analysts expect Shirakawa to repeat the central bank's neutral stance on monetary policy after he said earlier this week that the BOJ is at a stage where it needs to carefully watch both downside risks to the economy and upside risks to prices.

The BOJ said on Tuesday that the economy is likely to grow much less than expected in the current fiscal year, while price pressures will rise more than the bank had forecast in its half-yearly economic outlook report.

On the same day, the central bank left interest rates unchanged at 0.50 percent.

The five-year yield edged down half a basis point to 1.125 percent JP5YTN=JBTC.

The two-year yield rose half a basis point to 0.760 percent JP2YTN=JBTC, off a two-month low of 0.745 percent hit this week.

The market showed no reaction to minutes of the BOJ's meeting in June, which showed that board members agreed that downside risks to the global economy remain high.