Japan's reaction after China announced the toughest measure yet against it. Major concerns in Tokyo

Japan on Wednesday described China's ban on dual-use exports as “absolutely unacceptable”, amid the imminent threat of wider restrictions that would mark yet another escalation in diplomatic tensions between Asia's biggest economies.

Dual-use goods are goods, software or technology that have both civilian and military applications, including certain critical minerals essential to the manufacture of drones and chips.

The diplomatic spat between Beijing and Tokyo erupted in early November last year after Japanese Prime Minister Sanae Takaichi said a Chinese attack on the democratically-governed island of Taiwan could be considered an existential threat to Japan. China considers Taiwan part of its territory, a claim rejected by Taipei.

Beijing reacted angrily, and although Tokyo tried to defuse tensions, a series of countermeasures saw diplomatic relations between the two countries sink to their lowest level in years. The latest and harshest retaliatory measure since the outbreak of the conflict was taken by China this Tuesday, when it announced a ban on exports of dual-use goods to military users in Japan or for any purposes that contribute to Japan's military capabilities.

“Such a measure, which is aimed exclusively at our country, differs significantly from international practices, is absolutely unacceptable and deeply regrettable,” the Japanese government's main spokesman, Chief Cabinet Secretary Minoru Kihara, said on Wednesday.

He declined at his daily news conference to comment on the possible impact on Japanese industry, saying it was not yet clear which items would be targeted exactly.

Japan's benchmark Nikkei stock index fell about 1 percent on Wednesday, bucking the trend toward all-time highs recorded by benchmark indices in the United States and Europe.

Shares in major military contractors Kawasaki Heavy and Mitsubishi Heavy were among the worst hit, with declines of around 2%.

China also threatens Japan with a ban on rare earth exports

China Daily, a newspaper owned by the Chinese Communist Party, reported on Tuesday, citing “sources familiar with the matter” that Beijing was considering further tightening restrictions on rare earth exports to Japan.

Such a move could have wide-ranging implications for Japan's manufacturing powerhouse, including the auto sector, a key to the island nation's economy.

Japan has tried to diversify its sources of rare earth supplies after Beijing restricted exports of the minerals in 2010, but it still depends on China for about 60 percent of imports.

Industry analysts point out that for some heavy rare earths, such as those used in magnets for electric and hybrid vehicle engines, Japan is almost completely dependent on China.

Japanese automaker Subaru said it was closely monitoring the situation, while other manufacturers such as Toyota and Nissan did not immediately comment.

How much such a ban would cost Japan's economy

A three-month restriction on Chinese rare earth exports, similar to the one in the 2010 dispute, could cost Japanese companies 660 billion yen ($4.2 billion) and reduce the country's annual gross domestic product by 0.11 percent, Takahide Kiuchi, an economist at Nomura Research Institute, wrote in a note on Wednesday.

A one-year ban would reduce GDP by 0.43 percent, he added.

Cameron Johnson, senior partner at supply chain consultancy Tidalwave Solutions in Shanghai, told Reuters that the Tokyo government is unlikely to stand idly by if Beijing's bans begin to target Japanese business more broadly.

“If Japanese civilian or commercial entities are targeted, we could see a retaliatory reaction from Japan,” he says.

According to him, such retaliatory measures could target areas such as semiconductors or other advanced manufacturing materials that China needs for its own supply chain.

The dispute between China and Japan is not likely to be resolved anytime soon

Separately, China on Wednesday launched an anti-dumping investigation into Japanese imports of dichlorosilane, a chemical critical to the semiconductor industry, the commerce ministry said on its website.

Analysts compare the current rift between the two countries to that sparked by Japan's 2012 decision to nationalize disputed islands, which sparked massive anti-Japanese protests in China and led to the suspension of meetings between the two countries' leaders for two and a half years.

“I think this situation will drag on for quite a while,” Keita Ishii, chairman of Itochu Corp, one of Japan's largest trading houses, said in a televised interview on Tuesday.

Asked at a regular press conference on Wednesday about the export restrictions on Japan, the Chinese foreign ministry spokesman reiterated Beijing's anger at Takaichi's comments on Taiwan.

“We urge the Japanese side to confront the root cause of the problem, reflect on its mistakes and retract its erroneous statements,” Mao Ning said.