UPDATE 1-Isuzu to build diesel engines for Toyota -paper

(Recasts with background, Isuzu comment)

TOKYO, June 15 (Reuters) - Toyota Motor Corp. 7203.T will outsource production of some diesel engines to Japan's Isuzu Motors Ltd. 7202.T starting in 2012, the Nikkei business daily said, as it aims to catch up to rivals in the promising field.

The report sent Isuzu’s shares as high as 657 yen, up 4.5 percent, in early trade.

Toyota, the world’s biggest automaker, bought 5.9 percent of Isuzu late last year to tap the Japanese truck maker’s expertise in diesel engines, and the partners had been negotiating details on how to cooperate based on a broad agreement to jointly develop small, next-generation diesel engines.

Both companies said that nothing had been decided.

Isuzu President Yoshinori Ida said last month the company would be ready to announce an outline when it unveils a new midterm business plan in July.

Toyota leads the industry in gasoline-electric hybrid technology but is a laggard in diesels, which emit more harmful nitrogen oxide (NOx) and particulate matter (PM) but are gaining traction as a cheaper alternative to save fuel costs.

Diesels typically get 30 percent better mileage than their gasoline counterparts and now make up more than half of new cars sold in Europe. Tailpipe emissions have also become much cleaner with new technology.

Toyota has its own diesel engines for cars such as the Yaris, Corolla and RAV4 in Europe, but emissions would have to be reduced when stricter regulations are passed.

The Nikkei said Isuzu would invest some 30 billion yen ($240 million) to build a new plant in Hokkaido to supply about 200,000 diesel engines a year exclusively to Toyota from 2012. The engines would be mounted on small cars destined for the European market, it said.

Isuzu has an unused plot of land in the northernmost Japanese island adjacent to an engine subsidiary’s factory.

Toyota's domestic rivals Honda Motor Co. 7267.T and Nissan Motor Co. 7201.T are moving faster in the diesel field.

Honda has said it would launch an internally developed diesel car in the United States by 2009 that would meet the country’s tough emissions standards to be introduced soon.

Nissan, which has a diesel partner in top shareholder Renault SA RENA.PA, has promised a diesel-version Maxima sedan for the United States in 2010.

Toyota has been less enthusiastic about the prospect of diesel vehicles outside of Europe, preferring to promote the hybrid powertrain that it dominates.

But clean-diesel cars are likely to gain momentum in the United States and Japan as Honda and Nissan join diesel-savvy European carmakers in announcing potential plans for those markets. In other major markets, diesels are also gaining popularity in India and South Korea.

Shares in Isuzu were up 3.2 percent at 649 yen in midmorning trade, while Toyota put on 1.3 percent to 7,670 yen, outperforming a 0.6 percent rise in the main Nikkei average.