By Ayai Tomisawa
TOKYO (Reuters) - Japanese stocks are set for an annual drop in 2016, ending a four-year 'Abenomics' rally, as corporate earnings are hit by a stronger yen, while uncertainty over the U.S. economy and European financial sector woes hit sentiment, a Reuters poll found.
Having fallen around 13 percent so far this year, the Nikkei benchmark <.N225> is expected to end the year at 17,500, according to the poll of 18 analysts conducted in the past week. That would be a gain of over 5 percent from Monday's close of 16,598.67 but a drop of about 8 percent this year.
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Japanese equity markets have surged in the four years since Prime Minister Shinzo Abe took office, with the Nikkei hitting an almost two-decade high in June 2015, on hopes his Abenomics policies of monetary stimulus, fiscal expansion and structural reforms would end decades of low inflation and weak growth.
But gains are expected to be limited for the rest of the year as the yen's exchange rate against the dollar is much higher than what most companies expect, which is likely to force firms to cut full-year earning forecasts, analysts said.
Most automakers expect the dollar to trade around 105 yen, they added, while many electronics makers forecast the dollar to trade at 110 yen. On Monday the USD/JPY <JPY=> was around 101.
"Most companies will likely report sharp declines in their July-September earnings," said Fumio Matsumoto, a senior fund manager at Dalton Capital Japan who expects the Nikkei to trade at 17,000 at the end of the year.
"Companies then will likely change their full-year forecasts and the market can get volatile before earnings to recover next year."
Forecasts from equity strategists for the Nikkei at the end of this year ranged from 12,000 to 19,000. By mid-2017, it is expected to recover to 18,000, according to the consensus, and the range was 9,000 to 20,500.
Also hurting sentiment is weakness in the banking sector, fueled by a sharp sell-off in some of Japan's largest banks, in the wake of news that Deutsche Bank <DBKGn.DE> is contesting a fine of up to $14 billion from the U.S. Department of Justice.
For 2017, positive catalysts, such as higher interest rates in the U.S. due to robust economic growth, a rising dollar and subsequent weakness in the yen, as well as receding uncertainty over the U.S. Presidential election, are expected to emerge, analysts said.
"Investors are expecting a U.S. rate hike as early as this December, and if it happens, the dollar-yen's strength will likely lift exporters," said Hiroyuki Fukunaga, chief executive of Investrust, who forecasts the Nikkei to trade at 20,500 in mid-2017.
"A risk is that Fed refrains from raising rates this year, which would make the stock market sluggish."
Meanwhile, investors saw Democrat Hillary Clinton as the winner of the first presidential debate last week over Republican Donald Trump, which lifted Japanese and U.S. stocks.
"If Clinton becomes president, investors' risk stance will likely recover," said Takuya Takahashi, a strategist at Daiwa Securities, who expects the Nikkei to trade at 18,500 in mid-2017.
Market participants said a Trump presidency could heighten risk aversion, with his protectionist trade policies seen hitting the U.S. economy.
At the end of 2017, analysts expect the Nikkei to trade at 18,500.
(Editing by Shri Navaratnam)