UPDATE 2-Inflation in Japan's capital accelerates, keeps rate hike prospects intact

Adds economists' comments, factory output data and BOJ governor's stance

By Leika Kihara and Satoshi Sugiyama

TOKYO, Dec 27 (Reuters) - Core inflation in Japan's capital accelerated in December while services inflation held steady, data showed on Friday, keeping alive market expectations for a near-term interest rate hike.

But factory output fell in November for the first time in three months, suggesting that softening overseas demand was taking a toll on the export-reliant economy.

The data will be among factors the Bank of Japan (BOJ) will scrutinise at its next policy meeting on Jan. 23-24, when some analysts expect it to hike short-term interest rates.

The Tokyo core consumer price index (CPI), which excludes volatile fresh food costs, rose 2.4% in December from a year earlier, compared with a median market forecast for a 2.5% gain. It followed a 2.2% year-on-year rise in November.

Another index that strips away both fresh food and fuel costs, which is closely watched by the BOJ as a better gauge of demand-driven inflation, rose 1.8% in December from a year earlier after increasing 1.9% in November, the data showed.

Service-sector prices rose 1.0% in December after a 0.9% gain in November, underscoring the BOJ's view that sustained wage gains are prodding firms to charge more for services.

"There's a chance higher wages will be passed onto services prices, which is positive for the BOJ in normalising policy," said Masato Koike, senior economist at Sompo Institute Plus.

The Tokyo inflation data, considered a leading indicator of nationwide trends, is closely watched by policymakers for clues on how much progress Japan is making towards durably meeting the BOJ's 2% inflation target - a prerequisite for more rate hikes.

But some analysts saw signs of weakness in Japan's economy and price momentum that could delay the BOJ's rate-hike timing.

The increase in Tokyo inflation was driven largely by higher utility bills and the price of food like rice, which could weigh on consumption and discourage firms from hiking prices further.

Separate data released on Friday showed factory output fell 2.3% in November from the previous month due to shrinking production of chip equipment and automobile, casting doubt on the strength of Japan's fragile economic recovery.

"When stripping away the effect of rising utility bills, there's no sign of strength in inflation," said Toru Suehiro, chief economist at Daiwa Securities, who expects the BOJ to hold off on raising rates in January.

The BOJ ended negative interest rates in March and raised its short-term policy rate to 0.25% in July on the view Japan was making steady progress on meeting its inflation goal.

The BOJ has held rates steady since then, including at last week's meeting. Governor Kazuo Ueda said he preferred to wait for more data to gauge next year's wage momentum and for clarity on the incoming U.S. administration's policy before hiking again.

All respondents in a Reuters poll published earlier this month expected the BOJ to hike interest rates to 0.5% by March next year. Its decision to keep rates steady this month has heightened market attention on whether a hike would come at its next meeting on Jan. 23-24, or a subsequent rate review on March 18-19.

(Reporting by Leika Kihara and Satoshi Sugiyama; additional reporting by Kentaro Sugiyama and Tetsushi Kajimoto; Editing by Sam Holmes and Shri Navaratnam)

((leika.kihara@thomsonreuters.com; +813-6441-1828; Reuters Messaging: leika.kihara.reuters.com@reuters.net))