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The yen soared to a four-month high against the dollar Tuesday after a surprise tweak to monetary policy by the Bank of Japan, which decided against hiking interest rates to tame decades-high inflation.
Rallying also against the euro, the yen's jump weighed heavily on share prices of Japanese exporters.
"The shift in (Bank of Japan) policy was slight," noted Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.
"The decision is being read as a sign of testing the water, for a potential withdrawal of the stimulus which has been pumped into the economy."
The Bank of Japan (BoJ) adjusted its parameters for controlling bond yields, in a shift away from its long-running dovish stance of keeping rates ultra-low to boost the struggling economy.
Inflation in Japan has risen sharply this year, with the consumer price index in October at 3.6 percent, the highest in four decades, though bank boss Haruhiko Kuroda and other officials have said that would be temporary, citing a lack of strong demand and wage rises.
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The BoJ move sent the yen to 131.01 per dollar, its strongest level since August.
Japan's unit has been hobbled this year by its central bank's determination to stick to its loose monetary policy -- hitting a 32-year low of around 150 to the dollar in October -- even as the Fed ramped up borrowing costs.
Tuesday's policy move "was bound to happen with inflation rising in Japan, it's just happened sooner than many thought", said Amir Anvarzadeh of Asymmetric Advisors.
"It could spark money flowing back into Japan."
Elsewhere in Asia, stock markets fell following a spike in Covid infections in China as officials roll back many of the strict containment measures that have been in place for almost three years.
The World Bank on Tuesday slashed its China growth forecast for the year as the pandemic and weaknesses in the property sector hit the world's second largest economy.
A so-called Santa rally appears to be eluding investors, with the mood dampened by last week's warnings from the Federal Reserve and European Central Bank that they would likely push interest rates higher than expected next year.
The remarks dealt a blow to a short rally across equities that had been fuelled by data showing inflation coming down.
"Those who were in the camp of a year-end rally are now second-guessing their investment thesis," said JC O'Hara of MKM Partners.
"The markets may have placed a little too much faith in Santa Claus and the rally he typically brings."
Adding to the selling pressure were comments from former New York Fed chief William Dudley, who told Bloomberg Television that any sign of optimism in markets could make monetary policymakers tighten even more.
Downbeat US housing data added to the gloom, with building permits dropping 11.2 percent month-on-month, which is a leading indicator for the key economic sector.
"That speaks to the waning confidence among homebuilders who recognize the affordability constraints for prospective buyers due to building cost inflation and much higher mortgage rates," said market analyst Patrick O'Hare at Briefing.com.
Nevertheless, Wall Street stocks managed to push into positive territory for much of the morning, although they fell back into the red as European markets closed.
In Europe, London ended the day higher, while Frankfurt and Paris slid lower.
Key figures around 1630 GMT
Dollar/yen: DOWN at 131.29 yen from 136.95 yen on Monday
Euro/dollar: UP at $1.0630 from $1.0610
Pound/dollar: DOWN at $1.2135 from $1.2148
Euro/pound: UP at 87.58 pence from 87.31 pence
New York - Dow: DOWN less than 0.1 percent at 32,738.88 points
EURO STOXX 50: DOWN 0.2 percent at 3,802.49
London - FTSE 100: UP 0.1 percent at 7,370.62 (close)
Frankfurt - DAX: DOWN 0.4 percent at 13,884.66 (close)
Paris - CAC 40: DOWN 0.4 percent at 6,450.43 (close)
Tokyo - Nikkei 225: DOWN 2.5 percent at 26,568.03 (close)
Hong Kong - Hang Seng Index: DOWN 1.3 percent at 19,094.80 (close)
Shanghai - Composite: DOWN 1.1 percent at 3,073.77 (close)
Brent North Sea crude: DOWN 0.5 percent at $79.39 per barrel
West Texas Intermediate: UP less than 0.1 percent at $75.25 per barrel