Nikkei defies economy gloom, rises on Wall St hope

* Nikkei surges after early fall over 3 pct to three-week low

* Short-covering emerges on hopes of Wall St rise

* Grim economic news weighs, challenge of Oct lows possible

* Eyes on Citigroup, GM ahead of three-day weekend in Japan (Adds stocks, details)

By Elaine Lies

TOKYO, Nov 21 (Reuters) - Japan's Nikkei average rose 2.7 percent on Friday, buoyed by short-covering on hopes of Wall Street gains and defying increasingly grim economic news, with Sony Corp (6758.T: Quote, Profile, Research, Stock Buzz) and other exporters climbing as the yen fell. Sumitomo Mitsui Financial Group (8316.T: Quote, Profile, Research, Stock Buzz) also rose after hitting a five-year low the day before, with battered fellow banks gaining as well. High-tech exporters hit hard in recent days by worry about growing global recession also rose.

But the long-term mood remained dark after shares in U.S. banking giant Citigroup (C.N: Quote, Profile, Research, Stock Buzz) plunged on fears about its future, taking its total losses this week to nearly half its market value, while uncertainty over a U.S. auto bailout continued to weigh.

Some in the market said reports that Citigroup is considering options such as a merger or selling parts of the company had given the market hope that a solution might be possible. But many market players remained pessimistic and said that depending what happens over the weekend -- which in Japan includes a holiday on Monday -- the Nikkei could retest October lows that saw it hit its lowest levels since 1982.

"There's a vacuum in terms of policy announcements with the G20 meeting behind us and the (George W.) Bush administration a lame duck, while (Japanese prime minister Taro) Aso isn't that strong either," said Koichi Ogawa, chief fund manager at Daiwa SB Investments.

"So we can't count on much market support from policy statements," he added. "The economy is bad globally and this is the darkest hour."

In a day of unusually volatile trade, the benchmark Nikkei .N225 ended 207.75 points higher at 7,910.79, rising more than 3 percent at one point in the last 30 minutes of trade. Earlier it fell more than 3 percent to 7,406.18, its lowest point since Oct 28 -- the day it touched a 26-year intraday low of 6,994.90.

It has lost 6.5 percent this week and 7.8 percent this month.

The broader Topix .TOPX gained 2.6 percent to 802.69.

U.S. stocks plunged again on Thursday on a flight from risk prompted by deepening economic fears. The benchmark Standard & Poor's 500 index .SPX hit its lowest level since 1997, completing the erasure of more than a decade of stock market gains. [.N]

But U.S. stock futures were climbing as the Tokyo trading day ended, and market players said this contributed to hopes that Wall Street could rebound, setting off a round of short-covering. SPc1 DJc1

Others said long-term investors such as public pension funds, a source of apparent support on several days earlier this week as well, may also be buying.

"Nobody expects the overall situation to improve, but the market is oddly sensitive to any sort of positive factor today," said Hideyuki Ishiguro, a supervisor in the investment strategy department of Okasan Securities.

"Longer-term, there doesn't seem to be much hope of a solution for General Motors, and risk aversion is even higher than it was when Lehman Brothers failed. The market could test the October lows next week."

EXPORTERS GAIN AS YEN FALLS

Exporters gained as the dollar rose by more than 1 yen over the course of the day .

Toyota Motor Corp (7203.T: Quote, Profile, Research, Stock Buzz) rose 4.6 percent to 3,080 yen. Other strong performers that erased earlier losses were Canon Inc (7751.T: Quote, Profile, Research, Stock Buzz), which climbed 3.3 percent to 2,695 yen and Sony, which surged 5.6 percent to 1,929 yen.

High-tech exporters that had been battered earlier this week also climbed, with Kyocera Corp (6971.T: Quote, Profile, Research, Stock Buzz) up 4.7 percent at 4,730 yen, becoming the second-biggest contributor to the Nikkei by volume weight after industrial robot maker Fanuc (6954.T: Quote, Profile, Research, Stock Buzz), which surged 13.4 percent to 5,680 yen.

Electronic parts maker TDK Corp (6762.T: Quote, Profile, Research, Stock Buzz) rose 5.5 percent to 2,900 yen.

Banks forged higher, with Sumitomo Mitsui Financial Group gaining 8.4 percent to 305,000 yen and Mizuho Financial Group (8411.T: Quote, Profile, Research, Stock Buzz) surging 13.9 percent to 226,900 yen. Mitsubishi UFJ Financial Group (8306.T: Quote, Profile, Research, Stock Buzz), which also touched a five-year low on Thursday, rose 2.5 percent to 492 yen.

Trade picked up, with 2.49 billion shares changing hands on the Tokyo exchange's first section compared with last week's daily average of 2.11 billion.

Advancing stocks outpaced declining ones by 3 to 1. (Editing by Michael Watson)