* Foreigners cutting risk on US debt woes - analyst
* Nikkei breaches 200-day moving average of 9,919
* U.S. debt ceiling crisis encourages selling
* Investors see increasing chance of failure to reach deal by Aug 2
By Hideyuki Sano and Ayai Tomisawa
TOKYO, July 28 (Reuters) - The Nikkei stock average fell sharply on Thursday to close below its 200-day moving average, as the market grew increasingly nervous about whether a deadlock in talks on the U.S. debt ceiling could be solved to avoid default before next week's deadline.
Also hurting sentiment were euro zone debt problems, with Italian and Spanish bonds under pressure, while U.S. data underscored the fragile state of economy.
Top U.S. lawmakers worked behind the scenes looking to salvage a last-minute deal from rival debt plans but a clear compromise has yet to emerge.
"There seems to be a chance that deal won't be reached by Aug. 2. I'm sure they are already considering a plan B for such a case (to avoid default) but markets would be thrown into a chaos at least for a while," said Norihiro Fujito, a senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities.
Expectations are growing that any deal will lack a comprehensive plan to cut the U.S. budget deficit, making credit downgrades more likely.
"Increasingly concerned about the possibility of a U.S. credit downgrade, foreigners are cutting back on risk positions," said Fumiyuki Takahashi, managing director at Barclays Capital.
"The standard view that 'America is strong' could be in jeopardy and if confidence in the U.S. is damaged, the stock market may not be able to avoid a serious sell-off."
The benchmark Nikkei extended losses in the afternoon on selling from hedge funds to drop 1.5 percent, its largest percentage fall in more than a month. It ended at 9,901.35, below its 200-day moving average of 9,921 in the first decisive break of the average in nearly a month.
The broader Topix index finished down 1.3 percent at 848.37.
For the Nikkei, possible support lies around 9,720, its June 1 high and its 65-day moving average.
Takahashi said the Nikkei could fall by 200-300 points if United States' AAA credit rating status was lowered, but the benchmark is expected to be supported above 9,500.
The three main ratings agencies have all warned the United States' coveted AAA credit rating status would be in serious jeopardy if the White House and Congressional Republicans cannot reach a deficit reduction agreement.
Adding to U.S.-related woes, concerns remain about a recovery in the U.S. economy with new orders for long-lasting U.S. manufactured goods falling unexpectedly in June, weighed down by weak receipts for transportation equipment.
Hopes for more strong quarterly results from the Japanese corporate sector lent some support to the Tokyo market, with companies like Hitachi Construction Machinery outperforming after robust earnings.
"Buying on dips in companies with good earnings may continue, but exporters may not fare well for the time being as long as there are concerns about the U.S. economy," said Hideyuki Okoshi, general manager at Chibagin Securities.
Hitachi Construction Machinery rose 3.8 percent to 1,745 yen after saying its April-June net profit surged 65 percent on the year to 2.3 billion yen ($29.5 million) while operating profit climbed 91 percent to 8.2 billion yen.
Panasonic rose 0.5 percent to 929 yen after sources said the company will sell its Sanyo Electric unit's washing machine and refrigerator operations in Japan and Southeast Asia to China's Haier Group Co for about 10 billion yen ($130 million).
But Advantest , the world's No.2 maker of equipment to make chips, plunged 6.9 percent to 1,400 yen after the company said quarterly operating profit fell 57 percent from a year earlier and warned that orders could level off in the current quarter.
The Japanese yen is nearing a record high against the dollar, raising worries about profits at Japanese exporters.
Although manufacturers such as Canon and Fanuc have posted solid growth in the April-June quarter despite the yen's rise, less competitive companies are likely to be more vulnerable, analysts said.
"Some excellent companies may be overcoming the higher yen. But you shouldn't think that goes for all other companies. Only a handful of competitive companies can do that," said Mitsubishi Securities Fujito.
In the Tokyo Stock Exchanges' first section, decliners outnumbered advancers by 1,288 to 278 while trading volume was 1.79 billion shares, slightly above the average for the past six days.
(Editing by Edwina Gibbs)