TOKYO (Reuters) ¿ A crushing election defeat for Prime Minister Shinzo Abe's ruling camp yesterday could hurt Tokyo shares, boost bonds and raise questions about the chance of an early interest rate hike, market analysts said.

Abe's conservative ruling bloc's loss of its majority in the upper house of parliament could paralyse policy-making, leading to political uncertainty that could make foreign investors wary.

Further clouding the outlook for Japanese markets are concerns about the health of US credit markets, analysts said.

"It will be hard to make a distinction between the impact of US stock falls on Friday and today's election, but Japanese stocks will likely fall and bond yields will dip on Monday," said Kiichi Murashima, an economist at Nikko Citigroup.

"It's hard to say about the yen," he said. "Subprime mortgage problems will help the yen to rise, but the election result may become a factor to sell the yen."

Concern about the US economy had already raised doubts about the likelihood of a Bank of Japan rate rise to 0.75 percent next month.

Expectations of an August rate hike, as measured by swap contracts on the overnight call rate, fell sharply to around 50 percent on Friday from around 70 percent the previous day.

"Politics will not directly affect the BOJ's policy, but if worries about the US markets have a prolonged impact, it could change the main scenario of an August rate hike," said Yasuhiro Onakado, chief economist at Daiwa SB Investments.

"Even so, the BOJ should be able to raise rates in September because economic fundamentals in Japan and the US remain firm," he added.

But some market analysts said the defeat of the ruling coalition meant that critics of BOJ rate hikes, such as Hidenao Nakagawa, secretary general of the ruling Liberal Democratic Party, would have less influence on central bank policy, increasing the chances of an August rate increase.

While market participants had already factored in a defeat by the ruling coalition, early results pointed to a worse-than-expected loss for Abe.

Public broadcaster NHK said its exit polls showed the LDP and its partner, New Komeito, winning between 39 and 55 seats far short of the 64 needed to keep their majority in the upper house, where half of the 242 seats were up for grabs.

Market sentiment had already been poor, as worries about the deteriorating U.S. housing market prompted a sell-off in global stock markets.

In the US, better-than-expected growth figures released on Friday were not enough to ward off a second straight day of heavy losses in the Dow Jones industrial average, which fell 1.5 percent to register its biggest weekly drop in five years.

Abe's coalition will not be ousted from government by the loss in the upper house, since it has a huge majority in the more powerful lower chamber, which elects the premier.