TOKYO Japan's Nikkei stock average slid more than 2 percent on Monday as weak sentiment following Standard & Poor's downgrade of the United States' credit rating was exacerbated by futures selling after Asian markets tumbled.
Analysts warned that persistent worries about the global economy could spark further selling in the longer term, while investors will continue reacting to the performance of other global markets.
"The three main concerns are S&P's downgrade of the U.S. debt rating, the ongoing European debt problems and inflation worries in China," said Masanaga Kono, chief strategist at Amundi Japan.
"After nothing specific came out of the G7 teleconference, futures players were testing the water for a while but reacted to sharp falls in Asian markets."
The benchmark Nikkei .N225 closed down 2.2 percent at 9,097.56 after dropping as low as 9,057.29. The broader Topix fell 2.3 percent to 782.86.
The Nikkei is now down 8.1 percent from its 25-day moving average, a sign that Tokyo stocks are oversold in the short-term, but U.S. market moves will likely remain the driving factor for now.
"The market may see a technical rebound in coming days but the direction of U.S. markets after the downgrade will likely dominate the mood," said Eiji Kinouchi, a chief strategist at Daiwa Securities Capital Markets.
Elsewhere in Asia, the Hang Seng Index .HSI plunged more than 4 percent to hit its lowest level in a year, while the Shanghai Composite Index .SSEC dropped more than 3 percent.
S&P cut the long-term U.S. credit rating by one notch to AA-plus on Friday on concerns about the government's budget deficit and rising debt burden.
Market participants are now looking to the Federal Open Market Committee meeting on Tuesday for indications as to whether the Federal Reserve might ease monetary policy further.
"Investors are focusing on whether the Fed may hint at a third round of quantitative easing or other easing measures. If it doesn't, investors may signal their disappointment by selling stocks," said Toshio Sumitani, a senior strategist at Tokai Tokyo Research Center. If that happens, the Nikkei may slip below 9,000 for the first time since March, he added.
Some market observers remain bearish about the global economy and its potential repercussions for the Japanese market. Goldman Sachs cut its recurring profit forecasts for companies listed on the Tokyo Stock Exchange's main board, saying they could expect a 5.2 percent decline in the financial year to next March.
The brokerage also revised down its targets for the Topix index to 850 from 890 in the next three months and to 900 from 910 in the next six months.
Ebara Corp (6361.T), a maker of pumps and air blowers, plunged 18 percent to 362 yen after the company on Friday reported a 58 percent decline in net profit for the April-June quarter. UBS Securities downgraded the stock to "neutral" from "buy."
Olympus (7733.T) fell 5.1 percent to 2,414 yen after it tumbled to a 2.15 billion yen ($27.4 million) net loss in the April-June quarter from a 1.5 billion yen profit a year earlier, due to weak sales following the March 11 earthquake and tsunami.
Honda Motor Co (7267.T) sagged 3 percent to 2,799 yen after the automaker said it plans to recall 2.49 million cars, small SUVs and minivans worldwide to repair a software problem that could affect automatic transmissions.
Kirin Holdings (2503.T) dropped 3.4 percent to 992 yen after the beer maker lowered its annual profit forecast, reflecting a fall in domestic sales after the March disaster and less-than-expected demand in the Oceania market.
Volume was moderate with 2 billion shares changing hands on the Tokyo stock exchange's main board, in line with last week's daily average. Declining issues outnumbered advancing issues by 1,521 issues to 108.
(Editing by Chris Gallagher)