By Satoshi Sugiyama and Kantaro Komiya TOKYO, Jan 7 (Reuters) – Japan said on Wednesday that China's ban on exports of dual-use items to the country was "absolutely unacceptable and deeply regrettable", as a diplomatic dispute between Asia's top two economies intensified. Dual-use items are goods, software or technologies that have both civilian and military applications, including certain rare earth elements that are essential for making drones and chips. Japanese Prime Minister Sanae Takaichi touched off the dispute with Beijing 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 of dual-use items for military use. "A measure such as this, targeting only our country, differs significantly from international practice, is absolutely unacceptable and deeply regrettable," Japan's Chief Cabinet Secretary Minoru Kihara, the government's main spokesman, told 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 around 1% on Wednesday, bucking a global trend that carried U.S. and European benchmarks to record highs, with stocks of major military contractors Kawasaki Heavy and Mitsubishi Heavy among the biggest losers, down about 3%. RARE EARTH RESTRICTIONS NEXT? China Daily, a newspaper owned by the ruling Chinese Communist Party, reported on Tuesday that Beijing is considering tightening the license review of rare earth exports to Japan more broadly, citing sources with knowledge of the matter. Such a move could have sweeping implications for the manufacturing powerhouse, including its key automotives sector, analysts say. While Japan has sought to diversify its supply of rare earths since China last throttled exports of the minerals in 2010, around 60% of its imports still come from China. A three-month curb on Chinese exports of rare earths, like that seen during the 2010, could cost Japanese businesses 660 billion yen ($4.21 billion) and shave 0.11% of 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. So far, China Customs data has shown no sign of a decline in rare earth exports to Japan, though the data is released with some delay. In November, the latest month for which there is data, exports grew 35% to 305 metric tons, the highest tally last year. BRACING FOR A LONG WINTER Since Takaichi's offhand remark on Taiwan in early November, Beijing has urged its citizens not to travel to 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 further escalate the dispute, sources told Reuters. The quarrel does not, however, appear to have damaged Takaichi's robust popularity at home, opinion polls show. Analysts have likened the rift to one triggered by Tokyo's 2012 decision to nationalise disputed islands that unleashed mass anti-Japan protests across China. Leaders did not meet for two and a half years during that dispute. "I think this will drag on for quite a while. President Xi seems a bit angry," Keita Ishii, president of Itochu Corp, one of Japan's biggest trading houses, said in a television interview on Tuesday. ($1 = 156.6800 yen) (Reporting by Satoshi Sugiyama, Kantaro Komiya, Tim Kelly and Rocky Swift in Tokyo; Liz Lee and Lewis Jackson in Beijing; Writing by John Geddie; Editing by Michael Perry)
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