(Adds economist's quote, graphic)
* Current account surplus +4.2 pct vs forecast -2.5 pct
* Japan's hefty holding of overseas assets offsets weakexports
* Outlook murky due to China's subdued growth, Europe debtcrisis
TOKYO, Oct 9 (Reuters) - Japan's current account surplusunexpectedly rose i n August from a year earlier due to anincrease in earnings on overseas investments, but saggingexports due to the faltering Chinese economy and Europe's debtcrisis still cloud the outlook.[JPCURA=ECI]
The 4.2 percent annual rise in the current account surpluswas the first in 18 months. It compared with the median estimatefor a 2.5 percent annual drop and followed a 40.6 percentdecline in the year to July.
Although slackening global demand will likely continue toweigh on exports, inflows from Japan's extensive holdings ofoverseas assets are likely to keep the balance in surplus.
But the surplus could narrow if China grows more slowly thanexpected and the euro zone debt crisis further dampens demandfor Japanese goods.
"The overall trend is that the current account surplus islikely to shrink in the future, because overseas economies areweak and this will pressure exports," said Norio Miyagawa,senior economist at Mizuho Research & Consulting Co.
"The government may want to consider some extra measures tosupport the economy, but it is unclear if the schedule inparliament will lead to a quick response."
Japan's current account and exports:
The current account, a broad measure of trade and otherinvestment flows, stood at 454.7 billion yen ($5.82 billion)compared with economists' median forecast for 425.5 billion yen,finance ministry data showed on Tuesday.
Japan's exports dropped for a third straight month in theyear to August while manufacturing sentiment hit its lowestsince February, more signs that weakening global demand istaking its toll on the export-reliant economy.
The economy has so far outperformed most of its peers in theGroup of Seven helped by spending on reconstruction from lastyear's earthquake and tsunami. But economists polled by Reuterssay project growth will likely stall the rest of this yearbecause of weak external demand and a strong yen.
The Bank of Japan kept monetary policy unchanged lastFriday, but left the door open to more monetary easing laterthis month by striking a pessimistic note on the state of theworld's third-largest economy.
The central bank is expected to cut its long-term economicand price forecasts due out at the Oct. 30 review, and Japanremains years away from achieving its 1 percent inflationtarget, sources told Reuters.
(Reporting by Kaori Kaneko; Editing by Eric Meijer)
Keywords: JAPAN ECONOMY/CURRENT