The Nikkei share average rose 1.04 percent to end above 16,000 for the first time in five years on Monday, partly due to bright prospects for the retail industry after Seven & I Holdings Co Ltd said it would buy a department store group.
Property, warehouse and other stocks closely related to domestic demand also gained, while TDK Corp extended losses on concern that a US take-over deal could cost the maker of hard disk drive heads its biggest customer.
The Nikkei rose 166.30 points to 16,107.67, its highest closing level since October 2000.
The broader TOPIX index also gained 0.67 percent to 1,648.94, hitting its highest close since May 2000.
Seven & I, Asia's biggest retailer by market value, said on Monday it would take over Japanese department store group Millennium Retailing Inc in a deal worth about $1.7 billion, creating the world's fifth-largest retailing group.
The deal would also push Seven & I past rival Aeon Co Ltd to become Asia's biggest retailer by sales.
Kazuyuki Naito, general manager at the equities sales division of Mitsubishi UFJ Securities, said news of the merger was well received in the market. He also said the retail sector was aided by industry data that showed Japan's nation-wide department store sales rose in November for the third consecutive month.
"There is speculation that a further industry shake up is ahead and stocks in the retail sector are all drawing buyers," he said. Shiroishi Nishi, general manager of equity marketing at Nikki Cordial Securities, agreed. "Behind this move are strong corporate capital spending and buoyant consumer spending," he said.
Seven & I soared by its daily limit of 11.3 percent to 4,910 yen to become the best performer among the Nikkei 225 components, while Aeon climbed 1.2 percent at 3,020 yen. Credit Saison Co Ltd, the second-biggest stakeholder in Millennium Retailing, the parent company of Japan's Seibu and Sogo department stores, jumped 9.1 percent to 6,250 yen after hitting a lifetime high of 6,550 yen.
Other retail-related shares also gained, with Fast Retailing Co Ltd, operator of Unique stores and Japan's biggest casual wear chain, jumping 9.6 percent to 12,150 yen and department store operator Matsuzakaya Co Ltd adding 0.8 percent to 1,078 yen.
Companies that do better in a robust domestic economy also rose on the back of a government survey released on Monday that showed Japanese manufacturers were more confident about business conditions.
Top real estate developer Mitsui Fudosan Co Ltd was up 2.6 percent at 2,400 yen and Japan's top warehouse firm, Mitsubishi Logistics Corp, jumped 10 percent to 2,030 yen.
TDK lost 7.6 percent to 8,030 yen, extending on Thursday's 10 percent fall. HDD maker Seagate Technology said last week it would buy smaller rival Mixture Corp, TDK's biggest client. The Japanese market was closed on Friday for a national holiday.
Other technology stocks were also lower as the dollar remained around 116.40 yen, near its level in late US trade on Friday when it slipped 0.4 percent as investors took profits on the US currency's sharp gains this year.
Top Japanese electronics conglomerate Hitachi Ltd fell 1 percent to 798 yen and Advantest Corp, the world's largest maker of chip-testing equipment, shed 1.8 percent to 11,220 yen.
Trade activity was the slowest in a week, with 1.87 billion shares changing hands on the Tokyo exchange's first section. Advancers beat out decline's 901 to 647.