Nikkei off 10-month highs in nervous trade before Fed

By Aiko Hayashi

TOKYO (Reuters) - Japan's Nikkei average retreated from 10-month highs on Wednesday after surprisingly negative U.S. data dampened economic recovery hopes, while investors nervously awaited the U.S. Federal Reserve's view on its monetary policy.

Japanese stocks dropped 1.4 percent, also hurt after Chinese stocks .SSEC sank more than 3 percent on deepening worries about a possible tightening of market liquidity, which also helped the yen strengthen against the dollar. .SS

Sharp Corp (6753.T) slid after a quake forced supplier Corning Inc (GLW.N) to halt production of LCD glass at a Japanese factory, while Astellas Pharma (4503.T) extended losses after Novartis' launch of the first generic version of its transplant drug triggered a ratings downgrade.

"The Fed's decision is really important because whether it will continue its easing policy or not will hugely affect fund flows and that would have a big impact on stock markets," said Kenichi Hirano, operating officer at Tachibana Securities.

The Fed will conclude a two-day policy meeting and release a statement around 2:15 a.m. EDT, with investors looking to see if it will unwind some unconventional easing measures currently in place and at its assessment of the economy.

In thin trade, the benchmark Nikkei .N225 slipped 150.46 points to 10,435.00 after rising to a 10-month high of 10,587.36 on Tuesday.

The broader Topix also fell 1.4 percent to 959.87.

Analysts said it was natural that investors have become cautious after the Nikkei recovered some 50 percent since its March lows.

"Recent trade in small ranges also is also putting pressure on the upside," said Fumiyuki Nakanishi, manager at SMBC Friend Securities. "Japanese stocks will likely keep up this cycle of advancing and then retreating at least until the election on August 30."

Surveys have shown Japan's opposition Democratic Party has a good chance of ousting Prime Minister Taro Aso's Liberal Democratic Party, ending almost of half a century of almost unbroken rule by the business-friendly party.

Worries about the sturdiness of the U.S. economic recovery were fed by a government report showing U.S. wholesalers cut their inventories of unsold goods for a 10th straight month in July, suggesting businesses remain skeptical about a return in demand.

Additional concern arose after Rochdale Securities analyst Richard Bove painted a gloomy outlook for the U.S. banking industry, saying he expected a short-term pull-back in bank stock prices and sending the S&P 500 financial sector .GSPF down 3.5 percent.

But the Nikkei shrugged off data showing Japanese wholesale prices fell a record 8.5 percent in July from a year earlier, highlighting growing deflationary pressure in the economy and limiting the Bank of Japan's scope for ending its unorthodox policy measures.

EXPORTERS DOWN

Sharp shed 3.8 percent to 1,072 yen, while other exporters also fell, hurt by a stronger yen which eats into their profits when they are repatriated.