The Nikkei average fell 0.79 per cent on Thursday as investors sold exporters such as Sony Corp following a tumble in US and European stocks and a rise in the yen.
Property stocks also weighed on the benchmark index, with Japan's largest property firm Mitsui Fudosan Co Ltd losing 2.4 per cent to 3,740 yen and second-ranked Mitsubishi Estate Co. Ltd. falling 2.4 percent to 3,730 yen on concerns about the impact of a possible interest rate hike on their earnings.
"It is inevitable that Japanese stocks and other global stocks come under stress as rising interest rates are expected in some parts of the world," said Tsuyoshi Segawa, equity strategist at Shinko Securities.
European shares fell for a third consecutive day on Wednesday after the European Central Bank raised interest rates, fuelling concerns that further rate hikes might be on the way.
US stocks also fell sharply for a second day after data showing higher-than-expected labour costs stoked worries about inflation and interest rates. "Japanese stocks are going with the flow of the global markets for today after advancing as part of a correction and before the major SQ due tomorrow," Segawa said.
The so-called SQ -- the settlement of Nikkei options and futures contracts -- will be announced on Friday.
The Nikkei finished the morning down 141.86 points at 17,899.07, and the broader TOPIX index shed 0.66 percent to 1,766.74.
The yen inched up after Asian stock markets tracked a drop in U.S. and European shares and took some of the shine off risky positions such as carry trades, in which purchases of high-yielding assets are funded with the low-yielding Japanese currency.
The dollar slipped 0.20 per cent to 120.85 yen in early trade, pushing further away from a four-month high of 122.14 yen hit late last week.
Tokyo saw active trade in the morning with 1.38 billion shares changing hands, up from 1.27 billion shares on Wednesday. Declining shares beat advancers by a ratio of nearly two to one.
Exporters, property firms down
Shares of electronics and entertainment conglomerate Sony and other exporters fell following a drop in U.S. and European shares and a rise in the yen.
Sony was down 1.3 per cent at 6,780 yen, Canon Inc. shed 0.8 per cent to 7,090 yen, and Advantest Corp. lost 2.3 percent to 5,220 yen. A stronger yen hurts exporters as it cuts the value of their overseas sales when translated back into the Japanese currency.
Expectations that the Bank of Japan may raise rates in the near future have pushed up yields on government bonds and hurt shares of real estate investment trusts (REITs), which have attracted buyers for their relatively high dividend payments.
Property companies tend to shoulder heavy debts to develop projects, making them vulnerable to any interest rate rises. The Tokyo Stock Exchange's REIT index was down 2.3 per cent to its lowest in more than a month.
Elsewhere, shares of Takeda Pharmaceutical Co Ltd lost 2.4 per cent to 8,140 yen after its North American unit said it would add a boxed warning to the label of its diabetes drug Actos to raise awareness of the risk of congestive heart failure.
Tokyo Broadcasting System Inc dropped 3.1 per cent to 3,820 yen after the Tokyo Shimbun newspaper said Internet firm Rakuten Inc had hinted it may be open to selling TBS shares.
Goodwill Group Inc remained untraded due to another glut of sell orders coming in at 61,800 yen, down 13.9 per cent from Wednesday's close.
The stock fell 12 per cent on Wednesday after Japan's Health Ministry decided not to renew licences for 80 per cent of home care nursing service centres run by Goodwill.