Japan's Nikkei average dropped 2.36 percent to its lowest in nearly three months on Friday on a plunge in the U.S. market and a stronger yen, while this Sunday's parliamentary election kept the market in check.

Canon Inc. tumbled 5.5 percent to 6,510 yen after cutting its annual profit outlook, becoming the biggest drag on the Nikkei, while Fujitsu Ltd. plunged 6.2 percent to 789 yen on its dimmer forecast.

An election for half the seats in the upper house of Japan's parliament will be held on Sunday, with the ruling Liberal Democratic Party seen faring poorly because of funding scandals and voter anger over lost pension records.

The stock market may dip if the ruling party loses by a hefty margin, but the effect could be short-lived, said Naoyuki Torii, general manager and strategist at Fukoku Capital Management Inc.

The market may experience downward pressure temporarily, he said. But corporate earnings are growing and the market should advance accordingly.

Still, he said he is concerned that some of the policies proposed by the opposition party Democratic Party of Japan could entail some additional fiscal spending, having a long-term impact on the financial markets.

The Nikkei was down 418.28 points at 17,283.81, the lowest close since May 1. The broader TOPIX index shed 2.16 percent to 1,699.71.

While some voice concern about U.S. subprime mortgage problems, Takahiko Murai, general manager of equities at Nozomi Securities, said the impact could be limited.

We are seeing a shrinking of investment money that has sought risky assets and high returns, he said. Investors, especially hedge funds, are trying to minimize the losses by selling some of the assets. Once the dust settles, we will again see that money coming back.

Naoki Iizuka, a senior economist at Mizuho Securities' Equity Research, agreed that economic fundamentals remain solid and added that attention should be focused on oil prices.

If oil prices stay above $70 a barrel, we will see a slowdown in the global economy, he said. If we start to see stagflation and global stocks fall as a result, that would be a scary scenario.

Trade volume picked up with 2.5 billion shares changing hands, compared with average daily volume of 2.3 billion shares in June. Declining shares outpaced advancers by a ratio of nearly 12 to one.

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The market saw mixed earnings results released after the close.

NTT DoCoMo Inc., Japan's largest mobile phone operator, posted a 25 percent fall in quarterly operating profit amid an escalating price war and stuck to its full-year forecast.

But Toshiba Corp., the world's No. 2 maker of flash memory chips, posted a 1.6 percent rise in quarterly operating profit on Friday and raised its first-half forecast.

Auto stocks declined as the dollar hit a fresh three-month low against the yen at 118.02 yen on electronic trading platform EBS in early Asian trade before recovering to around 119.10 yen.

Honda Motor Co. Ltd. lost 2.5 percent to 4,310 yen and Toyota Motor Corp slipped 1.6 percent to 7,260 yen.

However, Sony Corp. bucked the overall bearish trend, gaining 1.1 percent to 6,420 yen, after the electronics giant said its quarterly profit more than trebled on strong sales of digital cameras and a softer yen.

A notable stock was Promise Co. Ltd. which plummeted 8.2 percent to 3,040 yen after it launched a bid for Sanyo Shinpan Finance Co. Ltd. and said first-half losses would be worse than first thought.

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