TOKYO (Reuters) - Japan's Nikkei average dipped on Tuesday, retreating from a seven-month closing high hit in the previous session, as weak U.S. manufacturing data triggered profit-taking on exporters, which have lately enjoyed a sharp bounce on a softer yen.
Calls by Shinzo Abe, leader of the main opposition party Liberal Democratic Party (LDP), for the Bank of Japan to embark on "unlimited easing" and set inflation target at 2 percent have weakened the yen over the past three weeks.
During that period the Nikkei has risen 8.9 percent, taking its year-to-date gain to 11.6 percent, narrowing the gap with the U.S. S&P 500's .INX 12.1 percent rise this year and the pan-European STOXX Europe 600's 12.9 percent gain.
But a surprising drop in U.S. manufacturing activity in November, which hit its lowest level in more than three years, prompted investors to lock in some of the recent gains.
The .N225 ended 0.3 percent lower at 9,432.46 points, as gains in defensive stocks, whose business performance is less impacted by the health of the global economy, helped limit losses.
Despite the pull back, many analysts remained upbeat on Japanese equities, which carry a 12-month forward price-to-earnings ratio of 12, slightly below S&P 500's 12.5 but above STOXX Europe 600's 11, according to Thomson Reuters Datastream.
"I am looking for the market to continue to rally after the election, subject to the LDP getting the most seats in the election," said Hidehiro Tomioka, head of equity investment at Manulife Asset Management in Tokyo.
"The pressure on the BOJ will continue after the election."
According to Reuters data, the most traded December Nikkei index options were a call with a strike price of 9,750 JNI097L2.OS, 3.4 percent above Tuesday's close, followed by another call at 10,000 JNI100L2.OS and a put at 9,250 JNI092X2.OS.
The broader Topix .TOPX index was flat at 781.97 in relatively light trade, with 1.74 billion shares changing hands, down from Monday's 1.87 billion and last week's average of 2.01 billion.
The yen was quoted at 82.11 to the dollar on Tuesday, up from its 7-1/2-month low of 82.84 touched on November 22.
Morgan Stanley MUFG said it expected the Topix to reach 910 by the end of 2013, 16.4 percent above where it closed on Tuesday.
"Don't fight the yen in 2013. With domestic political catalysts underway with lower/upper house elections and change in the BOJ governor, our FX team thinks the yen can weaken to as much as 92 yen to the dollar by 1Q 2014," Morgan Stanley MUFG analysts wrote in a report.
Mobile operator Softbank Corp (9984.T) advanced 0.5 percent, while the food sector .IFOOD.T added 0.6 percent.
HSBC raised its weighting on Japanese equities in its global portfolio model to 'neutral', although it remained pessimistic on Japan's long-term outlook, citing valuations and many Japanese companies losing international competitiveness.
"The chances are increasing that the Bank of Japan, which over the past few years have been reluctant to undertake aggressive QE, might change its stance," it said.
"All the major political parties have declared they will push the BOJ to ramp up its unorthodox monetary easing measures. It is not a foregone conclusions that this will happen -- the BOJ is likely to fight back -- but investors would be wise not to take a strong positions against it."
Additional reporting by Ayai Tomisawa; Editing by Kim Coghill