Large manufacturers expect a further improvement in business conditions in the next three months, according to the September survey, though it is seen as marginal in an recovery in the Japanese economy that is increasingly tentative.

Europe's debt crisis will keep the Bank of Japan edgy but the central bank is expected to refrain from easing monetary policy in a two-day review ending on Friday unless there is market turmoil seen as threatening Japan's recovery.

The Tankan roughly matches economic cycles so the central bank closely watches the survey results in gauging the economy's underlying trend in guiding monetary policy.

The BoJ could, however, come under pressure to increase asset purchases further to support growth in the coming months, as the government has been slow to compile a spending package for the bulk of reconstruction from the March 11 disaster.

"The headline figures indicate a moderate recovery at manufacturers. But if you look carefully you can see the heavy burden of a higher yen, and their profits are under pressure," said Hideo Kumano, chief economist at Dai-ichi Life Research Institute.

"Additional easing measures will be taken if the dollar falls below, say, 75 yen. Today's data reinforces views that the government and the Bank of Japan will take coordinated steps to tackle any excessive appreciation of the yen."

The headline index for big manufacturers' sentiment matched market forecasts, improving to plus 2 in September from minus 9 in June, when sentiment tumbled in the aftermath of the disaster, which ravaged northeast Japan.

Automakers' sentiment index improved at the fastest pace on record, underscoring the view that Japan has shaken off supply constraints from the disaster.

The index for December was seen at plus 4, roughly matching a market median estimate of plus 3, showing firms expect conditions to improve further.

Big non-manufacturers' sentiment improved by 6 points to plus 1 in September, roughly in line with the median forecast of plus 2. But they saw no further improvement in the next quarter, underscoring weakness in domestic demand. 

The world's No.3 economy probably emerged from recession as it recovers from a slump after the March disaster. But growth remains modest with analysts expecting a bigger slowdown in the final months of the year than previously thought.

Worries about a global recession, Europe's debt crisis and persistent yen strength have cast doubt on the central bank's view that external demand can help Japan's economy recover toward the end of this year. 

Big firms plan to increase capital spending by 3 percent in the current fiscal year to March 2012, less than the 4.2 percent projected by markets with a stubbornly strong yen seen hurting corporate profits.

The yen stood traded at around 77 yen to the dollar on Monday, much higher than the average 81.15 yen that big manufacturers surveyed by the central bank project for the current business year.

"The assumed rate for dollar/yen shows that companies still think current yen strength is temporary and that earnings will improve. This is overly optimistic and there is room for a downward revision," said Seiji Adachi, senior economist at Deutsche Securities in Tokyo.

The central bank believes the Tankan results are roughly in line with its view that while the global slowdown is slowly affecting sentiment in some sectors, Japan's economy is headed for a moderate recovery toward the end of this year. 

But it will conduct a more thorough overview of its economic scenario when it reviews its long-term economic forecasts in a twice-yearly outlook report due Oct. 27. 

It is expected to project that core consumer inflation will stay below 1 percent — a level it sees as desirable price growth — until the year to March 2014, signaling that it will maintain interest rates effectively at zero for years to come. 

In a sign of the fragile state of the economy, a separate BOJ survey showed household sentiment worsened in the third quarter with more respondents complaining of falling income.

An index subtracting the ratio of households who feel their livelihood worsened from a year ago from those who believe it improved stood at minus 62.4 in September, worsening 2.9 points from June, the BoJ survey showed.