* Yen falls then recovers after BOJ's share buying decision
* BOJ seen positive for stocks but extent of impact doubted
* RBA slashes interest rates 100 bps to 3.25% as expected
* Australian dollar rallies vs yen and dollar
By Masayuki Kitano
TOKYO, Feb 3 (Reuters) - The yen fell after the Bank of Japan said on Tuesday it would start buying shares held by Japanese banks, but then recovered as optimism in the stock market gave way to renewed risk aversion on earnings concerns.
The BOJ said it would start buying up to 1 trillion yen ($11.1 billion) worth of shares held by financial institutions, with the purchases up until April 2010 in shares rated BBB- or above by ratings agencies..
The yen initially dropped against the dollar and the euro as shares gained on the news, but investor caution, never far below the surface, returned as analysts questioned how effective the move would be in stabilising the broader financial system.
"I think the market misunderstood the purpose of the measures and interpreted it as a step to boost the stock market," said Toru Umemoto, chief foreign exchange strategist for Barclays Capital in Tokyo. Rather, the scheme was aimed at supporting lending by major banks, Umemoto said. The Australian dollar rallied against the yen and the dollar after Australia's central bank cut its key cash rate 100 basis points to a record low 3.25 percent.
The rate cut came after Australia's government unveiled a new stimulus package totalling A$42 billion on Tuesday for the rapidly cooling economy.
"The interest rate cut was 1 percentage point as expected, and the market took that positively," said Akira Kato, a senior manager for Bank of Tokyo-Mitsubishi UFJ's foreign exchange trading department.
The rate cut was seen as a sign that Australian authorities were taking proactive measures amid the global financial crisis, Kato said, adding that if the Reserve Bank of Australia had made a smaller rate cut the market might have reacted negatively.
The Australian dollar also got a lift against the yen from the BOJ's announcement, he said.
The dollar rose 0.1 percent from late U.S. trading on Monday to 89.52 yen. It had gained to highs around 90.00 yen earlier, up from 89.40 yen before the BOJ announced it would buy shares from banks.
The Australian dollar climbed 0.7 percent to $0.6355 and jumped 1 percent to 57.04 yen.
The yen is regarded as a safe haven currency as Japanese banks' losses from the credit market turmoil have been limited compared to their U.S. and European peers, and it tends to fluctuate in line with perceived shifts in risk appetite.
BOJ'S EQUITIES BUYING
Market players were sceptical that the BOJ's plan to buy shares from financial institutions would be enough to spur a sustained rally in Tokyo shares and recovery in risk appetite.
The Nikkei share average closed down 0.6 percent after rising by over 2 percent at one stage. Market players said deterioration in the economy and corporate earnings offset the BOJ move.
The timing of the announcement, which came ahead of a scheduled policy meeting on Feb. 18-19, raises questions, said Tomoko Fujii, head of Japan economics and strategy for Bank of America in Tokyo.
"I am very curious as to why it came out today," she said, adding that focus may turn to the conditions of Japanese banks' balance sheets.
Koji Fukaya, senior currency strategist for Deutsche Securities, said that the BOJ would likely buy shares that financial institutions were looking to sell to the market. The overall impact on the stock market may be neutral, he said.
"The measure may remove some negative impact but I do not think it will go so far as to have a positive impact," he said.
The BOJ's step was unlikely to alter the yen's overall trend, Fukaya said, adding that the risk of Japanese institutional investors repatriating funds from abroad ahead of Japan's fiscal year-end in March remained.
The dollar, which hit a 13-year low of 87.10 yen on trading platform EBS in January, may fall towards 87 yen to 85 yen by the end of March, Fukaya said.
The euro, which hit a seven-year low of 112.08 yen on EBS in January, could slide towards 110 yen, he said.
The euro was barely changed at $1.2835 and 115.05 yen. ($1=89.75 yen)
(Editing by Brent Kininmont)