By Satoshi Sugiyama and Kantaro Komiya TOKYO, Jan 7 (Reuters) – Japan called China's ban on dual-use exports for its military "absolutely unacceptable" on Wednesday, amid a looming threat of broader curbs on vital rare earths in an escalating dispute between Asia's top two economies. Dual-use items are goods, software or technologies that have both civilian and military applications, including certain critical minerals essential for making drones and chips. Japanese Prime Minister Sanae Takaichi touched off the dispute late last year by saying a Chinese attack on democratically-governed Taiwan could be deemed an existential threat to Japan. China regards Taiwan as part of its territory, a claim the island rejects. Beijing has demanded she retract the remarks, which she has not done, prompting a series of countermeasures, the latest of which was Tuesday's ban on exports to military users or for any purposes that contribute to Japan's military strength. "A measure such as this, targeting only our country, differs significantly from international practice, is absolutely unacceptable and deeply regrettable," said Japan's top government spokesman, Chief Cabinet Secretary Minoru Kihara. At a daily press conference on Wednesday, he declined to comment on the possible impact on Japanese industry, saying it remained unclear exactly what items would be targeted. Japan's Nikkei share index fell about 1% on Wednesday, bucking a trend of record highs in U.S. and European benchmarks. Stocks of major military contractors Kawasaki Heavy and Mitsubishi Heavy were among the biggest losers, down about 2%. RARE EARTH CURBS NEXT? Beijing is considering further clamping down on exports of rare earths to Japan, the China Daily, a newspaper owned by the ruling Chinese Communist Party, said on Tuesday, citing sources with knowledge of the matter. Such a move could have sweeping implications for the manufacturing powerhouse, including its key automotive sector. Japan has sought to diversify its supply of rare earths since China last throttled exports of the minerals in 2010, but still relies on China for about 60% of imports. For some heavy rare earths, such as those used for magnets in electric and hybrid vehicle motors, for example, Japan is almost totally dependent on China, analysts say. Japanese automaker Subaru said it was closely monitoring the situation, while peers such as Toyota and Nissan did not immediately comment. A three-month curb on Chinese exports of rare earths, similar to that of the 2010 dispute, could cost Japanese businesses 660 billion yen ($4.2 billion) and shave 0.11% off annual gross domestic product, Nomura Research Institute economist Takahide Kiuchi said in a note on Wednesday. A year-long ban would knock 0.43% off GDP, he added. Tokyo will not likely sit idly by if Beijing's bans do start to target Japanese business more broadly, said Cameron Johnson, a senior partner at supply chain consultancy Tidalwave Solutions in Shanghai. "If there are Japanese civilian or commercial entities targeted, you could see the Japanese retaliate," he said. Such responses could target areas such as semiconductors or other high-end manufacturing materials China needs for its own supply chain, he added. Separately on Wednesday, China launched an anti-dumping probe into imports from Japan of dichlorosilane, a key chemical for the semiconductor industry, the commerce ministry said on its website. BRACING FOR A LONG WINTER Since Takaichi's offhand remark on Taiwan in early November, Beijing has urged citizens not to visit Japan, halted imports of Japanese seafood and cancelled meetings and cultural events. U.S. President Donald Trump, who brokered a fragile trade war truce with Chinese President Xi Jinping late last year and plans to travel to Beijing in April, has asked Takaichi not to escalate the dispute further, sources told Reuters. The quarrel does not, however, appear to have damaged Takaichi's robust popularity at home, opinion polls show. Analysts liken the rift to one triggered by Tokyo's 2012 decision to nationalise disputed islands that set off mass anti-Japan protests in China, and halted meetings of the two countries' leaders for 2-1/2 years. "I think this will drag on for quite a while," Keita Ishii, president of Itochu Corp, one of Japan's biggest trading houses, said in a television interview on Tuesday. Asked about the export curbs on Japan at a regular press briefing on Wednesday, China's foreign ministry spokesperson reiterated Beijing's anger over Takaichi's Taiwan comments. "We urge the Japanese side to confront the root cause of the issue, reflect on its mistakes, and retract the erroneous remarks," Mao Ning said. Later in the day, Japan's Kyodo news agency reported that the Japanese government last week protested to China over signs of new offshore gas exploration activities in the East China Sea. The activities were observed on the Chinese side of the median line between the two countries, Kyodo said. Tokyo has lodged similar protests with Beijing before, citing a 2008 agreement on cooperation in natural resources development in the East China Sea. Japan's Foreign Ministry was not immediately available to comment on the Kyodo report. ($1=156.6800 yen) (Reporting by Satoshi Sugiyama, Kantaro Komiya, Tim Kelly, Rocky Swift, Daniel Leussink and Maki Shiraki, Kiyoshi Takenaka in Tokyo; Liz Lee, Ethan Wang, Xihao Jiang, Shi Bu and Lewis Jackson in Beijing; Writing by John Geddie; Editing by Michael Perry and Clarence Fernandez)
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