Honda Motor Co <7267.T>, Japan's No.2 automaker, posted an 88 percent fall in operating profit as demand slumped, but beat expectations for a loss and lifted its forecast for the year on the back of an improved outlook for its global car sales.

Like most Japanese automakers, Honda is expected to see its earnings improve as production volumes return from the low levels since late last year when sales plunged after the collapse of U.S. bank Lehman Brothers squeezed the auto loans market and led to job losses.

Still, most auto executives have yet to call a convincing recovery in demand and are trying to battle a sales decline with cost-cutting as much of the demand in developed markets is artificially supported by government schemes to encourage consumption.

Honda, also the world's top motorcycle maker, made an operating profit of 25.2 billion yen ($267 million) in the April-June quarter, against a profit of 210.5 billion yen a year earlier and a consensus estimate for a 106 billion yen loss in a survey of four analysts polled by Thomson Reuters.

It made a net 7.6 billion yen in the first quarter compared with a profit of 173.4 billion yen a year ago.

For the financial year to March 31, 2010, Honda expects an operating profit of 70 billion yen and net profit of 55 billion yen. Three months ago, it had forecast the profits at 10 billion yen and 40 billion yen.

The maker of the popular Accord and Fit models lifted its global car sales forecast to 3.295 million vehicles from 3.210 million, for the year to March 2010.

While Honda has fared better than many rivals in Japan and China this year, as government incentives helped sales of its smaller, fuel-efficient vehicles, investors are keen to see signs of a recovery in the United States and Europe, where its sales lag the market with sharp double-digit falls.

Its new Insight hybrid car has sold well at home, but it faces competition in the United States where Toyota Motor Corp's <7203.T> new Prius has been stealing the show with a roomier, bigger and more fuel-efficient alternative at a deep discount to the previous version.

Honda now sees a stronger yen against the dollar, averaging 91 yen for the financial year, while it expects a stronger euro of 127 yen versus the previous 125 yen assumption.

Honda has deliberately held back shipment of the Insight to the United States to meet robust orders in Japan where the model is more profitable at current exchange rates, making it difficult to gauge latent demand in North America.

Shares in Honda have risen 44 percent in the year to date, in line with Tokyo's transport sub-index <.ITEQP.T>.

Before the results were announced, Honda ended up 1.1 percent while the transport sector gained 0.3 percent.

($1=94.38 Yen)

(Reporting by Chang-Ran Kim; Editing by Lincoln Feast and Valerie Lee)

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