* Nikkei extends gains on economic hope, but wariness reigns
* Watching new government, especially currency policy
* Brokerage reports boost Canon, Olympus
By Elaine Lies
TOKYO, Sept 16 (Reuters) - Japan's Nikkei average extended gains to 1.6 percent on Wednesday as Canon Inc and other exporters powered higher, bolstered by better-than-expected U.S. retail sales data and a halt in the yen's rise on the dollar.
But gains were limited with investors wanting to monitor the policies of Japan's incoming government, with Yukio Hatoyama set to take office as prime minister and announce his new government later in the day after a resounding Aug. 30 election win.
Market players also said the dollar's fragility against the yen would help keep Japanese stocks range-bound for some time.
"If the yen weakened I think we'd see the Nikkei try for 10,500 again but if the current strong yen trend continues, especially over the upcoming long weekend, this could really increase pessimism in the market," said Hiroaki Osakabe, a fund manager at Chibagin Asset Management.
"There's a tug-of-war going on between the situation shown by good global economic indicators and the situation in Japan, where a strong yen and relatively high valuations are keeping the Nikkei from rising -- and this tug-of-war will continue."
U.S. stocks rose on Tuesday to 2009 highs as improvement in retail sales in August reassured investors about a rebound in U.S. economic demand. A rise in the government's Producer Price Index signalled increased consumption of raw materials.
Investors were also encouraged by Federal Reserve Chairman Ben Bernanke, who spoke on the one-year anniversary of the collapse of Lehman Brothers and said the recession "is very likely over."
The benchmark Nikkei rose 163.45 points to 10,381.07 by midafternoon, while the broader Topix rose 1.1 percent to 942.40.
"Japanese companies with global operations are being bought for now, with investors encouraged by Bernanke's comment that the recession was probably at an end and after solid retail sales data," said Fumiyuki Nakanishi, manager at SMBC Friend Securities.
"But the new government is seen as tolerant towards a stronger yen, which is negative for the stock market, and investors are now cautiously looking for further comments on its currency policies."
Investors were also nervous about actively taking positions ahead of a five-day holiday period from Sept. 19-23.
Exporters climbed on short-covering and were also helped by a halt in the yen's advance against dollar. The dollar hit a seven-month low below 91 yen earlier this week.
Investors fret about a stronger yen as it curbs exporters' profits when they are repatriated.
Canon jumped 4.8 percent to 3,720 yen after Nomura Securities raised its rating on the company to "buy" from "neutral" and hiked its target price to 4,218 yen from 3,462 yen.
Nomura cited Canon's Monday announcement that it will start providing its latest multi-functional printers to Hewlett-Packard later this year.
Tokyo Electron Ltd gained 4.4 percent to 5,520 yen and industrial robot maker Fanuc Ltd added 2.2 percent to 7,770 yen.
Olympus Corp advanced 3.7 percent to 2,510 yen after Credit Suisse reinstated coverage of the camera and medical equipment firm with an "outperform" rating and a target price of 3,100 yen. (Additional reporting by Aiko Hayashi; Editing by Chris Gallagher)