* China warns of damage to economic ties
* China hints that it see nothing wrong with boycott of Japanese goods
* Protesters outside Japanese embassy in Beijing
By Ben Blanchard and Xiaoyi Shao
BEIJING, Sept 13 China warned Japan on Thursday that trade could be hurt by the flare-up in tension over a group of disputed islands that is fraying ties between Asia's two biggest economies.
The latest warnings from China brought a call for restraint from Japan, which on Tuesday announced it had bought the disputed islands in the East China Sea from a private Japanese owner, an act Beijing called a violation of its sovereignty.
"With Japan's so-called purchase of the islands, it will be hard to avoid negative consequences for Sino-Japanese economic and trade ties," Chinese Vice Minister of Commerce Jiang Zengwei told a news briefing.
The islands were at the centre of a chill in 2010 after Japan arrested a Chinese trawler captain whose boat collided with Japanese Coast Guard vessels near the disputed area.
The United States this week urged both sides to tone down increasingly impassioned exchanges over the longstanding row.
China is Japan's largest trading partner. In 2011, their bilateral trade grew 14.3 percent in value to a record $345 billion.
Jiang hinted that his government saw nothing wrong with peaceful boycotts of Japanese goods. China is a major market for Japanese cars and electronics, and China's National Business Daily newspaper said that travel agents had reported cancelled bookings for tours to Japan.
"I still haven't seen any actions by Chinese consumers in response to the Japanese violation of Chinese territorial sovereignty, but if we do see them expressing their stance and views in a reasonable way, I think that would be their right," Jiang said.
Speaking in Tokyo, Japanese Foreign Minister Koichiro Gemba called for both sides to keep the broader picture of their relationship in mind when dealing with the spat.
"It is important that both Japan and China respond calmly with a broad picture in mind. I believe stable progress in Sino-Japanese relations should not be hindered by this development, and would like to ask China to take calm and appropriate steps," he told reporters following Jiang's comments.
A Nissan Motor Co Ltd executive said last week that the tensions were affecting business with China.
The row is the latest episode in troubled relations between the neighbours. The dispute erupted again last month when Japan detained a group of Chinese activists who had landed on the islands, known as Senkaku in Japanese and Diaoyu in Chinese.
China's Foreign Ministry on Thursday repeated its condemnation of the Japanese purchase of the islands.
"People from all walks of life in China are greatly indignant at Japan's act, and China will continue to take decisive measures," ministry spokesman Hong Lei told reporters.
COMPOUNDED BY DOMESTIC POLITICS
The row has been compounded by domestic political concerns on both sides, with China's ruling Communist Party preoccupied with a looming leadership handover, while Japan's ruling Democrats struggle with poor poll figures ahead of elections expected late this year.
Those complications could make it even harder for the two governments to find a quiet way to back down.
"The Diaoyu Islands dispute is pushing China and Japan towards confrontation, and Japan has chosen the wrong opponent at the wrong time and in the wrong place," said a commentary in the Global Times, a popular Chinese tabloid.
"The Diaoyu Islands conflict is a new turning point in the deterioration of Sino-Japanese relations."
On Thursday, protesters gathered at the Japanese embassy in Beijing, waving banners and the Chinese national flag while singing the country's national anthem and shouting slogans.
Police allowed them to take turns standing in front of the embassy in groups of 40 or so. A few demonstrators tossed water bottles over the gates and into the compound.
"Down with Japanese imperialism! Get the hell out of the Diaoyu Islands! Boycott Japanese goods! Declare war on Japan!" some of them shouted.
Japan's Foreign Ministry on Wednesday issued an advisory for Japanese nationals in China, urging them to stay away from rallies and refrain from behaviour that might attract attention.
In 2005, a surge of anti-Japanese resentment spilled over into sometimes violent protests in Chinese cities, and demonstrators trashed Japanese-owned shops.
One demonstrator said bitter memories of Japan's wartime occupation of China and other Asian neighbours continued to stoke public anger. China's official memorial day for the war on Sept. 18 could act as another focus for that ire.
"It's more than about the Diaoyu Islands," said Han Xue, an office worker holding a small Chinese flag. "It's about wanting to avenge all the millions of Chinese the Japanese killed in the war. We can never forget that."