JGBs slide on stronger-than-expected BOJ tankan

* JGBs fall on profit-taking after tankan

* Japan business sentiment worsens less than expected

* Benchmark yield jumps sharply from seven-week low

* Nikkei rebound adds to downward pressure on bonds

By Shinichi Saoshiro

TOKYO, July 1 (Reuters) - Japanese government bonds fell sharply on Tuesday after the Bank of Japan's tankan survey showed that business sentiment worsened less than expected in the past three months.

Market players had been eyeing the quarterly survey to see how much the surge in oil and commodity prices had hurt confidence and capital spending plans of large companies.

The benchmark 10-year yield, which hit a seven-week low on Monday, jumped on news that the June tankan's headline figure for big manufacturers was higher than the median market forecast. [JPBCLG=ECI]

A rebound by the Nikkei average .N225 partly in response to the tankan added to downward pressure on bonds.

"JGBs have been rising for almost half a month now, and participants were looking for a chance to sell," said Atsushi Ito, a fixed-income strategist at Morgan Stanley.

"The market was braced for a downbeat tankan, so the better-than-expected results triggered profit-taking."

Still, the tankan did not show the economy in a particularly positive light.

The headline big manufacturers' index of plus 5 beat the median forecast of plus 3 but was the lowest since September 2003.

Furthermore, capital spending plans by companies, though above expectations, were the weakest in six years for a June survey.

"The survey confirmed the economy is moderately slowing, indicating a deterioration in business confidence as well as corporate profits," said Makoto Yamashita, chief JGB strategist at Lehman Brothers.

"The tankan was not something that would prompt investors to expect a BOJ rate hike. It focuses attention on downside risks to the economy, and losses in JGBs should be limited," he said.

Swap contracts on the overnight call rate JPONIBOJ=TRDT are showing around a 30 percent chance of a quarter-point BOJ interest rate increase by year-end. That's up from 25 percent on Friday but still significantly lower from early June, when such a move had been fully priced in.

September futures eventually trimmed losses, with bargain hunting emerging after the knee-jerk reaction to the tankan. The futures 2JGBv1 dropped to a low of 134.50 then recovered to 134.78, down 0.67 point.

The 10-year yield JP10YTN=JBTC rose 6.5 basis points to 1.655 percent after touching 1.660 percent. It reached a seven-week low of 1.585 percent on Monday.

The five-year yield JP5YTN=JBTC was 7 basis points higher at 1.240 percent.

Traders said super-long bonds fared slightly better amid the broad sell-off due to some buying interest from index players extending duration at the beginning of the month. The yield on the 20-year JP20YTN=JBTC rose 5.5 basis points to 2.220 percent. (Additional reporting by Rika Otsuka; Editing by Brent Kininmont)