UPDATE 2-Japan machinery orders seen as bullish after May's smaller than expected fall

expected fall@

* May core orders -3.7 pct m/m vs forecast -5.5 pct

* Core orders +16.5 pct yr/yr vs forecast +8.6 pct

* Govt keeps assessment, says orders "picking up"

* Policymakers eye capex for clues on Q2 GDP rebound

(Adds analyst's quote) TOKYO, July 11 (Reuters) - Japan's core machinery orders fell in May, pulling back from the previous month's big gain, although the decline was softer than expected, easing some concerns about a slowdown in capital expenditure amid a worsening U.S.-China trade conflict. Capital expenditure is a bright spot in Japan's economy, which suffered a first-quarter contraction after its longest growth run since the bubble economy of the 1980s. Economists are watching capital spending closely for clues on the strength of an expected economic rebound in the second quarter. Cabinet Office data out on Wednesday showed core orders, a highly volatile data series regarded as an indicator of capital spending in the coming six to nine months, fell 3.7 percent, smaller than economists' median estimate of a 5.5 percent drop. It followed a 10.1 percent rise in April. The data came a week after the Bank of Japan's key tankan survey showed big firms planned to raise capital spending by a solid 13.6 percent this fiscal year, even as manufacturers' business confidence soured for two straight quarters in June. "The orders data as well as the tankan confirmed bullish capital expenditure," said Koya Miyamae, senior economist at SMBC Nikko Securities. "Core orders look set to grow for a fourth straight quarter in April-June." Economists expect capital expenditure to be underpinned by the need to upgrade production capacity, boost software, invest in labour-saving equipment to cope with labour shortages and to meet infrastructure needs ahead of the 2020 Tokyo Olympic Games. Still, policymakers and analysts are carefully watching how trade disputes between the United States and China - Japan's two major export destinations - may affect corporate capital spending plans in an export-reliant economy. U.S. tariffs on $34 billion in Chinese imports took effect on Friday. Beijing responded with its own measures. The Trump administration raised the stakes in its trade war with China on Tuesday, saying it would slap 10 percent tariffs on an extra $200 billion worth of Chinese imports. May, while service-sector orders increased 0.2 percent. The Cabinet Office kept its assessment of machinery orders unchanged to say they are picking up. Compared with a year earlier, core orders, which exclude those for ships and from electricity utilities, rose 16.5 percent in May, versus an 8.6 percent gain seen by economists. The Bank of Japan's June tankan showed big manufacturers planned to increase capital expenditure by 17.9 percent this fiscal year, the fastest gain since 2015. Large non-manufacturers plan to raise capex by 11.2 percent, which would be the fastest increase since 1990 at the peak of the bubble economy. The central bank will scrutinise the orders and other data at its rate review ending July 31, at which its nine-member board will conduct a quarterly review of its long-term growth and inflation outlook.

(Reporting by Tetsushi Kajimoto Editing by Eric Meijer)