The Nikkei stock average extended losses in afternoon trading on Monday, touching a five-month low as worries about the U.S. economy offset signs that the Japanese authorities stand ready to quell any further yen strength.
The index fell as low as 8642.79, breaking below the previous five-month low of 8,656 set on August 9, before stabilising.
"The next downside target would be 8,600, but we aren't seeing big moves these days, as investors remain cautious," said Nagayuki Yamagishi, an investment strategist at Mitsubishi UFJ Morgan Stanley Securities.
Market participants closely monitored foreign exchange markets for clues as to whether financial officials would order intervention to protect the profits of key exporters such as Toyota Motor and Canon.
Some investors said that, even if Japanese authorities directly intervened in the currency market, the effect on the stock market would be short-lived.
"If the government unilaterally intervenes in the currency market the Nikkei may regain some 100 points, but Japan's efforts alone will not change the fundamentals," said Mitsushige Akino, a fund manager at Ichiyoshi Investment Management.
A prolonged period of yen strength could force big manufacturers to ratchet down their profit outlooks, and a spate of downward revisions would hurt sentiment already fragile due to fears about the economic outlook in Japan's key export markets.
But in the meantime, bargain hunting could limit the downside, as analysts said Tokyo stocks remained undervalued compared with their global peers.
Firms listed on the Tokyo Stock Exchange's first section had an average price-to-book-value ratio under one, which is usually an indication they are oversold.
"It's easy to buy Japanese stocks with such cheap valuations, and this gives the market some support," said Hiroichi Nishi, general manager at SMBC Nikko Securities.
The benchmark Nikkei slipped 0.8% to 8,650.84 The broader Topix index was down 1.0% at 743.94.
Volume was relatively thin, with 1.5 bln shares changing hands on the Tokyo Stock Exchange's main board. Daily volume last week averaged 1.7 bln shares.
U.S. RECESSION FEARS
Market players are increasingly on edge about the possibility that Japan may intervene in the wake of the dollar's slide to a record low around 75.95 yen Friday.
After the close of the morning stock session, the dollar briefly surged above 77 yen amid talk of bids by a U.S. bank. But it quickly pared those gains and was last trading around 76.72 yen.
Japanese Finance Minister Yoshihiko Noda said on Monday that authorities would take decisive action against speculative moves in the currency markets, signalling Tokyo's readiness to intervene to check yen strength.
Shares of camera and office equipment maker Canon trimmed gains but was still up 0.6% at 3,485 yen while rival Nikon Inc erased gains and skidded 0.7% to 1,599 yen. Other exporters fell, with Toyota Motor Corp dropping 1.8% to 2,718 yen.
Analysts said investors were awaiting a speech by Federal Reserve Chairman Ben Bernanke on August 26 in Jackson Hole, Wyoming, for clues as to how policymakers plan to handle the turmoil in financial markets and for any hints that more U.S. easing might be ahead.
"Investors want to see if U.S. markets will have a technical rebound tonight as they fell sharply at the end of last week," said Yutaka Miura, a senior technical analyst at Mizuho Securities. "If they slide again, repercussions in the Japanese market will likely be serious."
On Friday, U.S. stocks fell after Hewlett-Packard's weaker outlook and corporate shakeup added to uncertainty for investors.
In Tokyo Monday, shares of Inaba Seisakusho gained 3.5% to 840 yen after the producer of steel storage units raised its operating profit estimate on Friday for the year ended on July 31 to 470 mln yen ($6.2 mln) from 60 mln yen, as cost-cutting measures offset the impact of higher steel prices.
Shares of Resort Trust were up 2.5% at 1,244 yen after Daiwa Capital Markets raised its rating on the membership hotel operator to "outperform" from "hold", citing better-than-expected business at its hotel restaurants, which rose to record high rates in July.
