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Nikkei drops to near 3-week low as spike in bond yields spooks investors

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TOKYO, Feb 26 (Reuters) - Japanese shares dropped on Friday, with the Nikkei on course to log its biggest fall since July, after a spike in global bond yields spooked investors already uneasy about the market's stretched valuation.

Nikkei average fell 2.54% to 29,400.80, hitting its lowest level in almost three weeks. If sustained, it will be the biggest daily drop since July 31, when it fell 2.82%.

For now, the Nikkei managed to find a support at its 25-day moving average of around 29,200.

The broader Topix lost 1.98% to 1,888.02

Except one, mining shares, all of the Tokyo Stock Exchange's 33 industry subindexes were in the red, with electronic machinery makers, pharmaceuticals and real estate companies also falling more than 2%.

Semi-conductor related shares, one of the main leaders of the market's rally to 30-year highs, succumbed to heavy selling, after U.S. chip shares fell 5.8%.

Sumco fell as much as 4.8% while Lasertec shed up to 5.8%. Advantest fell 5.1% while Screen Holdings lost 4.6%.

Precautions about rising inflation and a weak U.S. bond auction boosted global bond yields, dampening investors' appetite for risk assets.

"In a nutshell, I think the stock market had risen a bit too much," said Soichiro Monji, chief strategist at Nishimura Securities.

Rising bond yields also hit assets that have been considered as an alternative to low-yielding bonds. The TSE's index of real estate investment trusts (REITs) fell as much as 3.0%.

But higher bond yields are seen as beneficial for Japanese financials, with Dai-ichi Life Holdings rising 1.3%.

Market players are now awaiting whether the Bank of Japan, which has refrained from buying stock exchange traded funds (ETFs) so far this month, will purchase them later in the day.

The central bank in its next policy meeting is expected to signal it will make its ETF purchases more flexible. (Reporting by Hideyuki Sano; Editing by Vinay Dwivedi)