* S&P cuts Japan rating
* Bini Smaghi expresses inflation concern
* Euro rises, yen falls
* Wall Street outlook mixed, stocks generally higher
By Jeremy Gaunt, European Investment Correspondent
LONDON, Jan 27 (Reuters) - Hawkish policy talk in Europe and a stark reminder in Japan of the fragile state of some developed countries' finances combined to drive up the euro and depress the yen on Thursday, while equities eked out modest gains.
Wall Street looked set for a mixed start.
Standard & Poor's surprised markets by downgrading Japan's long-term sovereign debt one notch from AA to AA minus, citing the country's ballooning deficit, which it said will further reduce Tokyo's already restricted fiscal flexibility.
The move will have a limited impact on Japan's ability to raise money on financial markets but it raised a red flag with investors about other leading countries' fiscal imbalances.
"It is not a good sign.... A major economy like Japan being cut is not going to go down very well," said Mark Priest, senior equities trader at ETX Capital.
Among the Group of Seven industrial countries, the United States, Britain, Italy and France are all carrying large deficits. Only Germany is looking sound and even it felt an impact as the cost of insuring its debt against default over five years hit its highest since March 2009.
Investors were also put on notice of potential tighter monetary policy in Europe by European Central Bank rate-setter Lorenzo Bini Smaghi, who said an expected rise in imported goods inflation could not be ignored.
Bini Smaghi's comments went to the heart of current investor concerns, highlighting the potential for inflation to prompt central banks to raise interest rates at a time when low rates are seen as key to boosting renewed economic growth.
DOUBLE WHAMMY
The yen fell broadly on the S&P move, initially prompting a sharp recovery for the dollar against a basket of currencies. At one point, the dollar rose more than 1 percent to 83.20 yen before dipping back to trade at 82.92 yen, up 0.8 percent.
Bini Smaghi, meanwhile, prompted investors to seek euros for potential greater returns from higher interest rates.
The euro rose a quarter of a percent to more than $1.37 and gained more than 1 percent against the yen to 113.87 yen.
"The ECB has started to show more concern about secondary price pressures, and the market has acknowledged that," said Gavin Friend, currency strategist at nabCapital.
Equity investors were less moved, although initially the S&P cut set off some wobbles.
World stocks as measured by MSCI were up around 0.1 percent. The pan-European FTSEurofirst 300 index of top shares was up 0.2 percent.
Before the S&P announcement, Japan's Nikkei average gained 0.7 percent.
Euro zone government debt yields rose as investors sold bonds, and the premium investors demand to hold peripheral euro zone paper rather than German debt also widened.
(Additional reporting by Joanne Frearson and William James; Editing by John Stonestreet)