By Ian Chua
SYDNEY (Reuters) - Japanese shares recoiled from a two-month high on Friday in a sudden reversal sparked by profit-taking before a weekend election that should see Prime Minister Shinzo Abe gain control of the upper house of parliament.
A big victory for Abe could allow him to push nationalist policies at the expense of his "Abenomics" agenda of monetary expansion, government spending and potentially painful structural reform, although markets hope he will continue to prioritise economic reform.
Tokyo's Nikkei ended 1.5 percent lower, having swung from gains of more than 1 percent to a fall of 2.7 percent. Friday's decline has just about wiped out most of this week's gains and the choppy session may make European investors cautious.
"A weak start is expected in Europe as some disappointing earnings results overnight from Google and Microsoft weigh on sentiment and Asia treads cautiously amid choppy trading," said Jonathan Sudaria, a trader at Capital Spreads in London.
Dealers said profit-taking by some large players pushed the Nikkei into negative territory, which then tripped large sales of stock futures that fuelled the selloff. Thin conditions in the market exaggerated the moves.
"It's like a mini-version of what happened in May," said Tachibana Securities strategist Kenichi Hirano, referring to the big plunge that the Tokyo market experienced two months ago.
"Although some foreign funds are likely to sell shares after the upper house election, I expect the Nikkei will top 15,000 next week."
Bourses across Asia were softer, with the exception of Indian stocks which reached a seven-week high. The market was underpinned by a rally in Tata Consultancy Services
MSCI's broadest index of Asia-Pacific shares outside Japan slipped 0.5 percent, and was on track to end flat for the week.
ELECTION EYED
Japan's ruling Liberal Democratic Party (LDP) and its New Komeito Party (NKP) coalition partner are expected to win resoundingly at Sunday's upper house election.
"The outcome from this weekend's upper house elections will help determine the ability of the Abe administration to deliver on structural reforms and its long-term growth strategy," Barclays Capital analysts wrote in a report.
"If the LDP-NKP coalition wins control of the upper house and receives a decent mandate for reform, we would remain comfortable with our USD/JPY forecast profile of 103 in 3 months and 105 in 12 months."
Friday's sudden pullback in the Nikkei, however, led investors to quickly unwind short yen positions, helping the Japanese currency bounce off lows.
That saw the dollar fall back to 100.05, from a one-week high of 100.86. The euro slipped to 131.47 from a seven-week high of 132.10 yen.
Against the dollar, the euro was a touch firmer at $1.3135, but still off this week's peak around $1.3179.
Investors are also keeping an eye on a G20 meeting of central bankers and finance ministers taking place in Moscow, looking for reassurance as China rebalances its economy and the Federal Reserve looks to reduce stimulus.
Fed Chairman Ben Bernanke said this week the U.S. central bank still expects to start scaling back its massive bond purchase programme later this year, yet he kept the option of changing that plan if the economic outlook were to deteriorate.
Latest data on the U.S. economy suggested the recovery was on track, with factory activity in the Mid-Atlantic region picking up in early July, while new claims for jobless benefits fell last week.
Bernanke told the Senate Banking Committee on Thursday it was too soon to judge if recent "mixed" signals from the U.S. economy would prompt the central bank to delay plans to trim its bond buying this year.
His pledge to be flexible soothed global financial markets this week and helped drive Wall Street to record closing highs.
Commodity markets also took heart, with copper recovering from a one-week trough to $6,940 a tonne, while gold bounced to $1,291 an ounce from this week's low of $1,270.41.
U.S. crude held near 16-month highs above $108 a barrel, further underpinned by signs of a stronger U.S. economy.
(Additional reporting by Tomo Uetake and Haruya Ida in Tokyo; Editing by Eric Meijer and Richard Borsuk)
