By Lisa Twaronite
TOKYO (Reuters) - Japanese stocks marked their biggest daily drop since August on Monday, helping the yen rebound from a fresh seven-year low against the dollar touched after news Japan unexpectedly fell into recession in the third quarter.
"European equities are set to open lower following Japan's dip into recession," Capital Spreads dealer Jonathan Sudaria said in a note.
Capital Spreads predicted Britain's FTSE 100 would fell 33 points, or 0.4 percent; France's CAC 40 would open down 20 points, or 0.4 percent, and Germany's DAX would open 66 points lower, or 0.7 percent.
Meanwhile, Shanghai shares edged up 0.2 percent. Hong Kong opened around 1 percent higher but quickly erased gains and was down 0.7 percent on suspected profit-taking by traders who had positioned for the launch of the Stock Connect scheme that will let Hong Kong and Shanghai investors buy and sell shares on each other's bourses.
A daily investment quota for the Shanghai leg of a stock market connect scheme was hit in early afternoon trading as investors piled into the relatively undervalued mainland shares.
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"The market had already responded to the stock link," Andy Wong, senior investment analyst at Harris Fraser (International) Ltd in Hong Kong said, referring to the Hong Kong market. "Short-term investors are taking profits from the market."
Much of the cash flow is expected to be northbound at first, as foreign investors on the Hong Kong Exchange target mainland shares under a daily quota of 13 billion yuan.
MSCI's broadest index of Asia-Pacific shares outside Japan was down 0.3 percent, as the disappointing Japanese growth data sent the Nikkei stock average tumbling 3 percent.
Japanese GDP contracted an annualised 1.6 percent in the July-September quarter, compared with a 2.1 percent increase forecast by economists in a Reuters poll. That followed a revised 7.3 percent contraction in the second quarter, which was the biggest slump since the March 2011 earthquake and tsunami.
The shockingly downbeat report reinforced expectations Prime Minister Shinzo Abe will delay a sales tax hike, set for October next year, after a hike in the tax in April took a heavy toll on consumption.
The dollar initially rallied as high as 117.06 yen, but gave up those gains in extremely volatile trade as the Nikkei extended losses. Many market participants, particularly foreign investors, sell the yen to hedge their equities positions, so the Japanese currency tends to gain whenever stocks drop. The dollar was last down about 0.4 percent at 115.74.
"Dollar/yen has been moving recently in close relationship with (Japanese) equities so the Nikkei's fall knocked the pair from its highs," said Masafumi Yamamoto, a market strategist at Praevidential Strategy in Tokyo.
"The GDP data was so unexpectedly weak and clouded many prospects taken for a given," he said.
The yen's renewed strength helped push down the dollar index about 0.2 percent to 87.369.
On Wall Street on Friday, U.S. shares were slightly lower, but still logged weekly gains and were underpinned by data showing most U.S. retailers reported strong sales in October and consumer sentiment rose to a seven-year high in November.
Two separate reports on Friday showed Americans' expectations for long-term inflation fell, and import prices slipped 1.3 percent in September as cheaper oil and a strong dollar slashed prices of imported items.
Leaders from the G20 group of nations agreed on Sunday to boost global growth, tackle climate change and crack down on tax avoidance, but ties between the West and Russia showed signs of fraying over the Ukraine crisis.
The euro added 0.2 percent to $1.2542, holding well above a two-year low of $1.2358 touched on Nov. 7.
In contrast with Japan, data on Friday showed the euro zone economy grew more than expected in the third quarter as France beat market forecasts and Germany narrowly avoided a recession. The 18 countries sharing the euro expanded 0.2 percent in July-September compared to the previous three months, when they grew 0.1 percent.
In commodities trading, U.S. crude dropped about 0.8 percent to $75.18 a barrel, moving back toward a four-year low of $73.25 marked on Friday. Brent crude shed 1.1 percent to $78.55.
Spot gold edged up slightly on the day to $1,189.08 an ounce, after its 2.5 percent surge on Friday on short-covering and fund buying.
(Additional reporting by Kazunori Takada in Shanghai and Shinichi Saoshiro in Tokyo; Editing by Shri Navaratnam and Eric Meijer)