Japan's Nikkei snapped a three-day winning streak on Friday after the U.S. Federal Reserve kept interest rates unchanged on worries about the global economy, while investors refrained from taking large positions before long holidays in Japan.
The U.S. central bank held rates steady in a bow to worries about the global economy, financial market volatility and sluggish inflation at home, but it left open the possibility of a modest policy tightening later this year.
The Nikkei share average dropped 1.6 per cent to 18,130.86 in midmorning trade, after rising 2.6 per cent over the past three days through Thursday. For the week, the index has dropped 0.3 per cent.
Markets in Japan will be closed from Monday through Wednesday for national holidays.
Traders said that the Fed decision left investors with two conflicting interpretations. Investors are concerned about the fact that the U.S. economy is not growing enough to warrant rate hikes, but at the same time, easy monetary conditions in the U.S. will now continue for an extended period of time, which should support the global equity markets, traders said.
"Global economic indicators will likely set the direction of the Japanese market for the time being," said Michiro Naito, executive director of equity derivatives at JPMorgan.
"China will continue to worry global investors, and if its growth is worse than expected, it will likely rattle global markets again. Whether volatility persists or not will also depend on any signs that measure global growth."
Analysts also said that the market will also take cues from Japanese companies' earnings statements for the first half year ending September, which should start to appear out in late in the month.
Dai-ichi Life Insurance Co, which invests most of the premiums it gets from policyholders in bonds such as U.S. Treasuries, dived 5.5 per cent.
Exporters lost ground after the dollar fell more than 1 per cent overnight, hit by the Fed's downbeat assessment of the U.S. economy. Toyota Motor Corp dropped 2.0 per cent, Honda Motor Co fell 2.6 per cent and Panasonic Corp shed 2.9 per cent.
The dollar stood at 119.77 yen during Asian trade.
Banks were lower, with Mitsubishi UFJ Financial Group falling 2.9 percent and Mizuho Financial Group shedding 2.4 per cent.
Bucking the weakness, Seven & i Holdings soared 3.5 per cent after the Nikkei newspaper reported that the chain will close its non-performing 40 Ito Yokado stores by the fiscal year ending Feb. 2020.
The broader Topix dropped 1.4 per cent to 1,470.85 and the JPX-Nikkei Index 400 declined 1.4 per cent to 13,203.66.