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* Capex outlook revised down more than expected
* Strong yen could weigh on sentiment in future
* BOJ move unlikely this week, doubts on policy next year
* Smaller firms under the gun amid sluggish domestic demand
(Adds details on small companies, yen, prices)
By Stanley White and Tetsushi Kajimoto
TOKYO, Dec 14 (Reuters) - Japanese business morale improved more slowly in the fourth quarter and large manufacturers surveyed by the central bank planned record cuts in capital spending, as a strong yen threatened a fragile economic recovery.
The Bank of Japan's quarterly tankan survey also showed lending to both big and small companies has barely improved from the previous survey in September.
Small companies expect their outlook to worsen in the first quarter, reinforcing the government's fears that a strong yen and deflation will push the economy back into recession before an election for parliament's upper house next year.
The government pressured the BOJ this month into launching a new funding operation that has lowered short-term interest rates. It has also criticised the central bank for ending measures that support corporate finance, saying the central bank made light of tight lending conditions for small firms.
"The dollar/yen rate is moving lower than expected and small and mid-sized firms forecast their conditions will worsen over the next three months," said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo.
"The BOJ is unlikely to take further steps at its policy meeting this week. But it is expected to continue to seek effective ways to combat deflation as excess production capacity and employees at Japanese firms will add further downward pressure to prices."
If the central bank does not make new moves this week, the minimal improvement in corporate finance, weak corporate spending and a rising yen could add to pressure for more monetary easing next year.
The headline index for big manufacturers' sentiment improved to minus 24 in December from minus 33 in September, the BOJ said on Monday, better than analysts had expected. The index hit a record low of minus 58 in the March survey. The median estimate for December was minus 27.
The index for March 2010 was seen at minus 18, showing firms expect conditions to improve over the next three months.
In contrast, small manufacturers expect their sentiment index to worsen to minus 42 in March from minus 40 in December.
For a graphic comparing the BOJ tankan with the Reuters tankan, click: http://link.reuters.com/cyb66g
CAPEX CUTS
Big manufacturers, a key driver of the economy, said they will lower their corporate spending by 28.2 percent in the fiscal year to March 2010, the biggest decline on record.
All large firms plan to cut capital spending by 13.8 percent in the current financial year, more than analaysts' median forecast for a 11.3 percent fall.
The yen is not very far from a 14-year high of 84.82 per dollar it hit last month on trading platform EBS, and that is clouding the outlook for exports and corporate spending.
Large manufacturers expect the dollar to average 92.93 yen in the fiscal year to next March, according to the tankan. That was down from 94.50 yen in the September survey, but manufacturers will have to lower expectations further should the yen continue to strengthen.
"Perhaps the biggest impact of the recent yen appreciation was reflected in the weak capex figures," said Mari Iwashita, chief market economist at Nikkko Cordial Securities in Tokyo.
"Deflationary pressures remain strong as company profits are squeezed by falling sales prices. The BOJ has no choice but to keep its easy policy."
Firms rated their financial conditions at minus 8 in December, little changed from minus 9 in September. Financing for large firms was unchanged at plus 6. Financing for smaller companies was minus 16, little changed from minus 18 in the previous quarter.
Deflation also remains strong, and that will pressure corporate earnings.
Japan's government agreed on a $81 billion stimulus package last week, aiming to prevent the economy from tipping back into recession as deflation persists and a strong yen threatens exports.
Economists say growth could still slow early next year as the impact of stimulus measures introduced by the previous government wanes.
The sentiment index for the BOJ tankan is calculated by subtracting the percentage of companies that consider conditions to be unfavourable from those that see them as favourable. (Editing by Kim Coghill)