The Nikkei lost 1.52 percent on Friday as concerns about rising interest rates hit property firms, often laden with debt, and Honda Motor Co Ltd and other exporters slipped after US and European stocks fell. Credit Saison Co Ltd and other consumer finance firms came under pressure on similar borrowing-cost worries.
The sector was also pressured after analysts highlighted a Supreme Court ruling on excess interest payments, which they said could make consumer lenders' losses much bigger than first thought.
Concern about interest rates cast a pall over the stock market, while Japanese government bonds also took a beating with JGB futures tumbling to an 11-month low and five-year yields hitting an all-time high on Friday.
"The stocks that have been bought because of their high dividend payments will be sold, while companies with less debt and good financial standing will be sought after," said Takahiko Murai, general manager of equities at Nozomi Securities.
Murai said rising interest rates were pushing up borrowing costs for overseas investors too, discouraging them from investing in stocks. The Nikkei shed 274.29 points to 17,779.09 and the broader TOPIX index lost 1.32 percent to 1,756.16.
Tokyo saw very active trade with turnover on the Tokyo Stock Exchange's first section hitting a record 5.1 trillion-yen. Trade volume also swelled with 3.45 billion shares changing hands, the highest in more than three months.
The Tokyo bourse said on Friday it has hired Daiwa Securities Group Inc, Nomura Securities and Morgan Stanley as lead managers for its listing, which is expected after December 2008.
Property stocks took big knocks. Mitsui Fudosan Co Ltd tumbled 5 percent to 3,620 yen while Mitsubishi Estate Co Ltd declined 4.5 percent to 3,600 yen. Credit Saison gave up 8.8 percent to 3,130 yen and its peer Aiful Corp lost 4.1 percent to 3,510 yen.
Hiroaki Kuramochi, managing director at Bear Stearns (Japan) Ltd, said there is a concern about a possible shift in allocations as a result of recent interest rate rises in Europe.
"There seems to be a view in the market that investors may shift their money to Europe," he said. The shift could be equities to bonds or dollar-denominated assets to euro-denominated assets, he added. "There is a concern about portfolio rebalancing."
The European Central Bank raised interest rates to a near six-year high of 4 percent on Wednesday and showed its readiness to hike again to combat inflationary dangers in a strongly expanding economy.
Rising yields on government bonds also prompted buying in some bank shares on expectations that their lending rates may rise and boost revenues. Resona Holdings Inc rose 3.3 percent to 316,000 yen and Mizuho Financial Group added 1.7 percent to 899,000 yen.
After the market closed Resona said it would repay 35 billion yen worth of public funds. Telecoms shares were split after data showed Softbank Corp signed up the most mobile phone subscribers in May. Softbank added 1.8 percent to 2,845 yen, while its bigger rivals fell, with KDDI Corp down 3.6 percent and NTT DoCoMo Inc losing 2 percent. Some exporters lost ground with Honda Motor skidding 2.8 percent to 4,160 yen.