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UPDATE 2-Uniqlo to hike prices in sign Japan winning fight against deflation

* Higher prices to be reflected from fall/winter collection

* Fast Retailing built up its empire during Japan's deflationary years

* Price hikes to help offset rising procurement costs, weaker yen

* Cost transfer comes amid falling profit margins for Uniqlo Japan

(Recasts with analysis on pricing power, confidence after tax hike)

TOKYO, June 10 (Reuters) - Fast Retailing Co's Uniqlo, Japan's biggest clothing store chain, will lift prices in its home market from next month - one of the most symbolic signs yet that the country is making strides in its battle to end 15 years of chronic deflation.

The price hikes of around 5 percent, which come on top of an increase in Japan's sales tax in April, are aimed at shoring up profit margins amid a weaker yen and a global rise in cotton and wool prices.

But they also show that the ability of Japanese firms to pass on prices has now extended beyond high-end retailers to a company that built its empire during Japan's deflationary years with affordable casual wear.

"This is representative that Japan is escaping deflation," said Koichi Fujishiro, an economist at Dai-ichi Life Research Institute.

"There has been a broad trend of rising prices led by higher import costs... but this will make it easier for other apparel makers to follow suit."

Bold monetary easing and fiscal spending under Prime Minister Shinzo Abe have kick-started the economy and boosted inflation expectations.

Japan's core consumer prices, excluding the estimated impact of the sales tax hike, rose 1.5 percent in April, up from 1.3 percent a month earlier and levels below 1 percent as recently as October. The Bank of Japan has set a goal of reaching 2 percent inflation during the fiscal year that starts next April.

While many Japanese companies have been on edge that the sales tax hike would cause a slump in demand, a Reuters corporate survey last month showed that for more than one quarter of respondents, year-on-year sales had actually risen in the weeks following the tax hike, while over 40 percent said sales had held steady.

Fast Retailing, a $35 billion company by market value, has been encouraged too, with Uniqlo's Japan same-store sales rising 3.3 percent in April and 4.1 percent in May from the year before.

Some retailers have already reported relatively brisk sales and higher price tags beyond the increase in the national sales tax to 8 percent from 5 percent.

Top Japanese department store operator Isetan Mitsukoshi Holdings Ltd said prices at its flagship stores in central Tokyo for some goods ranging from clothing, accessories such as handbags and scarves to kitchen items had risen 'several percent'.

"There's no sense that consumers are holding back," an Isetan Mitsukoshi official said.

At Taka-Q Co, a men's clothing retailer, a company source said that product prices have risen beyond the sales tax hike.

CONSUMER RESPONSE UNCERTAIN

Unlike some apparel makers, Uniqlo, which has more than 860 outlets in Japan, had refrained from raising base prices fearing consumers would be turned off given its reputation of offering affordable clothing.

But rising procurement costs, along with frequent discounting and higher labour costs, have caused a steady fall in Uniqlo domestic profit margins - a primary concern for investors.

Uniqlo faces a further rise in labour costs as it plans to hire about 16,000 regular staff in Japan over the next several years. That will include hiring of some its part-time workers, who currently receive little or no benefits.

Credit Suisse analyst Taketo Yamate said that while Uniqlo's new pricing strategy helps reduce concerns about its domestic operations, it remains to be seen how consumers would respond to the higher prices.

"Now that the price hike has made news, there's a new concern over how much this would affect sales and traffic at stores," he said. "If revenue falls, fixed costs would rise and profit margins will worsen."

Uniqlo's domestic operating profit margin fell to 14.2 percent in the business year that ended last August, from 21.4 percent three years earlier.

Overall operating profit for Fast Retailing, which also includes apparel brands such as Theory and GU, is projected to set another record in the year to August driven by a rapid expansion overseas, mainly in Asia.

Shares in Fast Retailing, which has the heaviest weighting in the benchmark Nikkei average, fell 1.6 percent on Tuesday, while the Nikkei lost 0.9 percent.

($1 = 102.3300 Japanese Yen)

(Additional reporting by Ayai Tomisawa; Editing by Edmund Klamann and Edwina Gibbs)