Nikkei falls back towards 10,000 on U.S. debt worries, yen
* Markets still expect last-minute deal on U.S. debt
* Five-day moving average of 10,018 holds
* Sharp selling not expected before earnings-Chibagin Asset
* Volumes at two-mth low, major players on sidelines
By Antoni Slodkowski
TOKYO, July 25 (Reuters) - The Nikkei average snapped a three-day run of gains on Monday after U.S. debt ceiling worries nudged the yen higher, but a key technical support held on hopes that a last minute deal will be reached and upcoming corporate earnings will be strong.
Most investors still assume that sanity will reign in Washington and a debt deal will be done, but the lack of progress in talks over how to cut the U.S. budget deficit is making market players nervous.
Banking shares , which have outperformed recently as euro zone officials agreed on steps to solve Greece's debt woes, bore the brunt of today's selling, with the sector subindex falling 1.5 percent and traders noting light volumes and a lack of major foreign players.
"Everyone is looking at how the debt ceiling talks affect the dollar/yen moves," said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.
"The market has already priced in the post-quake recovery by Japanese manufacturers and exporters, but the yen's rise comes as a big negative surprise. With such a strong currency it's hard to imagine a long-term recovery in corporate earnings," added Ogawa.
The dollar slipped in early Asia trade on Monday, falling to a near four-month low of 78.13 yen , from 78.52 yen on Friday. It trimmed its gains and was trading at 78.35 by late afternoon.
The benchmark Nikkei average closed down 0.8 percent at 10,050.01 on Monday, holding above support at its 5-day moving average at 10,018. The broader Topix also shed 0.8 percent, to 861.91.
Volume fell to a two-month low with 1.4 billion shares changing hands on the main board, below last week's lukewarm daily average of around 1.6 billion shares.
Market players said losses were limited ahead of corporate earnings later this week and as investors were cautious about the possibility of foreign exchange intervention if the yen strengthens sharply.
"Company earnings will likely provide some support this week. Macro indicators such as export data are showing signs of recovery, so there won't be much selling going forward," said Fujio Ando, senior managing director at Chibagin Asset Management.
After the bell, Canon Inc posted a 31 percent decline in quarterly operating profit on Monday, hurt by production halts due to parts shortages after the March 11 earthquake, but it raised its full-year forecast due to a faster recovery than expected.
The world's biggest maker of digital cameras lifted its annual operating profit forecast to 380 billion yen, above a market consensus of 365 billion yen.
Full coverage of U.S. budget and debt:
Possible outcomes for U.S. debt talks:
How US debt talks became a crisis:
Insider: Debt impasse weighs on U.S. image:
Republicans and Democrats in the U.S. Congress were each trying to put together their own plan after talks with President Barack Obama broke down over the weekend, heightening fears of a catastrophic U.S. debt default that could roil the global economy.
Exporters, sensitive to the rising yen, lost ground, with bellwether Toyota Motor falling 1.4 percent to 3,290 yen and Sony shedding 2.2 percent to 2,054 yen.
But shares of drilling-related companies gained in heavy volume after the Nikkei business daily reported a government-funded experiment will try to produce natural gas from methane hydrate on the sea floor by the end of fiscal 2012.
The only company in Japan involved in probing undersea oil and natural gas fields, Japan Drilling , jumped 5.7 percent to 3,170 yen, reaching a three-week high, while boring machine maker Koken Boring Machine rose 2.5 percent to 536 yen.
Kawasaki Heavy Industries , a major foreign supplier of train technology to China, were hit by a slide in shares of Chinese rail equipment makers after a deadly train crash at the weekend triggered concerns about the safety of China's fast-growing rail network.
Kawasaki ended down 2.9 percent at 298 yen. Chinese rail equipment makers fell as much as 16 percent.
Initial reports from China were that the trains involved in the collision were made with Chinese technology, but media reports Monday laid the blame on "foreign technology." (Additional reporting by Antoni Slodkowski; Editing by Edwina Gibbs)
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