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TOKYO, Oct 6 (Reuters) Japan's official foreign reserves, the world's second largest, rose to a record $881.273 billion at the end of September, the seventh consecutive monthly increase, the Ministry of Finance said on Friday.

The reserves increased from $878.748 billion a month earlier as a decline in bond yields overseas boosted the value of bonds held in the reserves, adding to interest rate income from bonds and bank deposits, a ministry official told reporters.

The figure keeps Japan at No. 2 among the world's largest holders of foreign reserves after China, whose reserves have grown rapidly as it fights persistent upward pressure on its yuan currency under its managed float regime.

A Chinese foreign exchange official said last month that the country's reserves, which reached a record $954.5 billion at the end of July, would top $1 trillion in September.

Japan's foreign reserves have held around record levels since March 2004, the last time Japan bought dollars to help stem any rise in the yen and protect what was then a fragile export-led economic recovery.

Japan's reserves ballooned after yen-selling intervention of a record 20 trillion yen ($170 billion) in 2003 and a further 15 trillion yen in the first three months of 2004.

Japan has not intervened in the market since then, however, as its economy has improved gradually and is now showing signs of breaking free from more than seven years of deflation.

Japan does not give a breakdown of the currencies in its foreign reserves, but its historical data on forex intervention, which has consisted mainly of dollar-buying operations, suggests that most of its hefty reserves are in dollars.

Reuters DKS VP0655