The Nikkei average fell 1.2 per cent after weak US manufacturing data fanned fears about the health of the global economy and pushed the dollar lower, although the heightened risk of intervention in currency markets by Japanese authorities lent support.
Data showed the US manufacturing sector grew at the slowest pace in two years in July, following similarly weak reports from much of Asia and Europe. This has made investors particularly jittery, especially ahead of US unemployment data on Friday.
"Investors are concerned about the yen's rise but what worries them more is whether demand for global cyclical companies' goods will stay intact or not," said Masanaga Kono, chief strategist at Amundi Japan.
Japan primed markets on Tuesday for currency intervention after the yen tested record highs overnight, signalling it may try to tame the unit with a combination of yen-selling and easier central bank monetary policy.
"If there is intervention this week, sentiment for companies may be lifted," said Fumiyuki Takahashi, managing director at Barclays Capital.
He added that as long as the dollar trades around 77-78 yen, companies would probably not cut their full-year outlooks as most have assumed a rate of 80 yen to the dollar and could fill the gap with cost cuts.
"But if the yen's weakness is short-lived and the dollar trades below 77 yen again, we may not be able to avoid a sell-off," he said.
The benchmark Nikkei finished at 9,844.59, erasing most of the gains it made the previous day. The next support level is seen at 9,750, which is seen as a potential strike price for Nikkei 225 options.
The broader Topix index fell 0.9 per cent to 843.96.
The dollar last traded at 77.25 yen.
Chip-related stocks underperformed as earnings underscored fears that a recovery in the chipmaking equipment market might come later than expected.
Tokyo Electron fell 6.2 per cent to 3,940 yen after the world's number two supplier of chipmaking equipment cut its annual forecast by half on Monday, hit by slowing investment by makers of chips used in PCs, smartphones and tablets. Nomura Securities cut its rating to "neutral" from "buy".
The same fears also hit Dainippon Screen Manufacturing, which dropped 6.2 per cent to 579 yen after Nomura similarly lowered its rating on the chipmaking equipment producer to "neutral" from "buy".
But Kirin Holdings Co outperformed the market, falling only 0.3 per cent to 1,148 yen after it said will spend $2.6 billion to take a controlling stake in major Brazilian beer and soft drinks maker Schincariol to expand its market share in the fast-growing South American economy.
Honda Motor was down 0.5 per cent at 3,110 yen, outperforming the market after reporting an unexpected quarterly profit and raised its annual outlook by more than a third, as the carmaker rebounded quickly from a severe parts
shortage due to the March 11th earthquake.
But Nomura Securities, which cut its rating to "neutral" from "buy", said the company's stock is no longer considered cheap due to increasing marketing costs in the US market.
Volume was thin, with 1.6 billion shares changing hands on the Tokyo stock exchange's main board, slightly lower than last week's daily average of 1.7 billion yen.
Reuters
