The Nikkei average slipped 0.16 percent on Wednesday as Mitsui Fudosan Co. Ltd. and other property firms fell on concerns about rising interest rates, while a slide in metal prices hit metal shares.
But the market received support from exporters such as Sony Corp. after the dollar struck a 4-1/2-year high against the yen on Wednesday as a sharp rise in U.S. bond yields boosted the dollar's allure while carry trades proved resilient.
Trading houses, which have large investments in the metal industry, were also hit, with Mitsubishi Corp. down 1.9 percent at 3,130 yen and Mitsui & Co. falling 1.6 percent to 2,405.
Caution ahead of the Bank of Japan's decision on interest rates on Friday and U.S. producer and consumer price data later in the week helped cap gains in the market.
The rising interest rates we have seen since June are negative in nature for stock markets as they stem from inflation concerns rather than from strong economies, said Soichiro Monji, chief strategist at Daiwa SB Investments' equity management department. This could shrink risk money and prompt foreigners to refrain from buying Japanese stocks.
He said inflation would inevitably push up salaries, eating into corporate profits.
But the level of interest rates in Japan is still relatively low in the world, and the scale of damage to stocks will be smaller than in other countries, Monji said.
The Nikkei shed 28.14 points to 17,732.77, while the broader TOPIX index was 0.33 percent lower at 1,745.92.
Japanese government bond futures tumbled to a seven-year low on Wednesday on a continuing slide in U.S. Treasuries and mounting concern that the Bank of Japan could lift interest rates as soon as August.
The benchmark 10-year yield rose 3.5 basis points to 1.960 percent, off an 11-month high of 1.985 percent hit earlier but still near last year's peak of 2.005 percent.
Norihiro Fujito, general manager of Mitsubishi UFJ Securities' investment research and information division, said higher interest rates had caused a shift in global money movements.
I'm seeing some equity sell-offs as global money that has been going into investment is gradually unwinding on worries that higher borrowing costs could cut corporate profits, Fujito said.
Trade slowed, with 2.1 billion shares changing hands on the Tokyo exchange's first section, compared with last week's daily average of 2.7 billion shares.
Declining shares outpaced advancers by 942 to 640.
PROPERTY, METAL SHARES DOWN
Property firms fell with Mitsui Fudosan down 1.9 percent at 3,540 yen and Mitsubishi Estate Co. Ltd. losing 1.7 percent to 3,470 yen.
Shares of Nippon Building Fund Inc. declined 1.7 percent to 1.72 million yen, helping send the Tokyo Stock Exchange REIT index down 2.5 percent.
The REIT index climbed 24 percent in 2006, compared with about a 2 percent rise in the TOPIX , and it has been seen as ready for correction.
Dowa Mining Co. Ltd. , a nonferrous metal manufacturer, dropped 3 percent to 1,216 yen, one of the stocks most affected by a slide in metal prices.
On Tuesday, nickel prices fell more than 6 percent and copper shed more than 2 percent after a slowdown in Chinese imports and a fall in global equity markets dampened sentiment.
Copper smelter Sumitomo Metal Mining Co. Ltd. tumbled 4.2 percent to 2,620 yen, while Toho Zinc Co. Ltd. lost 1.7 percent to 1,113 yen.
NEC Tokin Corp. fell 3.3 percent to 465 yen after it announced a recall of 134,000 cellphone battery packs that could generate heat in some circumstances.
Among exporters, Sony Corp. rose 1.2 percent to 6,660 yen and Tokyo Electron Ltd. gained 1.5 percent to 8,580 yen.
After the closing bell, Nippon Steel Corp. , Japan's largest steelmaker, said it would spend about $50 million to raise its stake in Godo Steel Ltd. to more than 15 percent, aiming to strengthen their business alliance. [ID:nT175781]