The Nikkei stock average fell 1.3 percent on Wednesday on a strong yen and selling of recent big gainers, while resource shares dropped after China tightened monetary conditions, sparking fear of slower demand. China surprised world markets by raising banks' reserve requirements, with an eye towards reining in surging asset prices.
Volume on the Tokyo exchange's first section hit its highest in seven months, boosted by active trade in Japan Airlines, which crumbled on growing expectations the airline is headed for bankruptcy and a delisting from the bourse.
"The Japanese stock market had become overheated following a big rally since December. On top of that, we now have China's decision to raise banks' reserve requirements," said Tsuyoshi Segawa, an equity strategist at Mizuho Securities. "It's hard to think the move would hinder China's economic recovery, but the news likely led some risk money to close positions for now."
The benchmark Nikkei shed 144.11 points to 10,735.03 after closing at a 15-month high on Tuesday. The broader Topix retreated 1.1 percent to 944.02. JAL tumbled to a record low of 7 yen, the second consecutive day it has fallen by its daily trading limit of 30 yen, and trade in the stock accounted for about 26 percent of the overall volume at 823 million shares.
Analysts noted that the Nikkei, which is hovering around 15-month highs, had been overbought and was poised for profit-taking even before the China news broke after Tokyo market hours on Tuesday. The Nikkei's relative strength index (RSI) fell to 64 on Wednesday after rising to 72 the previous day.
Over 70 is considered overbought territory, so market players said some downward adjustment - particularly in resource shares, which have gained recently - was only natural. The China move spurred selling in shares of metal stocks as commodities prices fell on concern that the country's purchases of natural resources might slow, while construction machinery firms, which have a big presence in China, also came under pressure.
Ferronickel producer Pacific Metals lost 4.7 percent to 685 yen, smelter Toho Zinc declined 3.8 percent to 460 yen and fellow smelter Dowa Holdings shed 3.3 percent to 525 yen. Komatsu Ltd, the world's second-biggest maker of earth-moving machinery, slid 2.9 percent to 2,036 yen and Hitachi Construction fell 2.3 percent to 2,506 yen.
Both gained sharply just a day earlier following strong Chinese data that boosted expectations of strong demand. Toyota Motor Corp and other exporters slipped after the dollar fell more than 1 percent against the yen on Tuesday. It was roughly flat at 91.05 yen on Wednesday.
Toyota retreated 1.5 percent to 4,055 yen, while electronics parts maker Kyocera Corp slid 2.2 percent to 8,320 yen. Steel companies slid after Credit Suisse downgraded its stance on the steel sector to "market weight", citing demand concerns at home and abroad. Nippon Steel lost 3.3 percent to 382 yen and JFE Holdings dropped 5 percent to 3,580 yen.