The yen fell and investors took a cautious stance on stocks and riskier assets on Thursday after Standard & Poor's cut Japan's credit rating in a forceful reminder of the fragile state of some leading countries' finances.

European stocks were flat to lower as were global equities, and euro zone peripheral debt came under stress.

S&P downgraded Japan's long-term sovereign debt one notch from AA to AA minus, citing the country's ballooning deficit, which it said will further reduce Tokyo's already restricted fiscal flexibility.

The move will have a limited impact on Japan's ability to raise money on financial markets but it raised a red flag with investors about other developed countries' fiscal imbalances.

It is not a good sign.... A major economy like Japan being cut is not going to go down very well, said Mark Priest, senior equities trader at ETX Capital.

Among the Group of Seven industrial countries, the United States, Britain, Italy and France are all carrying large deficits. Only Germany is looking sound and even it felt an impact as the cost of insuring its debt against default over five years hit its highest since March 2009.

The yen fell broadly on the S&P move, prompting a sharp recovery for the dollar off an 11-week low against a basket of currencies <.DXY>.

Earlier dollar weakness had come in response to the Federal Reserve giving no sign it may scale back its loose monetary policy.

The dollar rose more than 1 percent to 83.20 yen before dipping back to trade at 82.82 yen.

The euro fell 0.3 percent to $1.3664 but rose 0.3 percent against the yen to 113.12 yen, having hit a two-month high around 113.59.

SHOT ACROSS BOWS

Equity investors also took note and stocks were generally flat to weaker.

World stocks as measured by MSCI <.MIWD00000PUS> were just in negative territory, held up by emerging markets <.MSCIEF>, some of whose strength reflected trading before the S&P move.

The pan-European FTSEurofirst 300 <.FTEU3> index of top shares was down 0.1 percent.

Before the S&P announcement, Japan's Nikkei average <.N225> gained 0.7 percent.

The premium investors demand to hold peripheral euro zone government bonds rather than German debt rose, also pressured by fresh political setbacks in Belgium.

Japan is the world's third largest economy and the news is bound to have a bearing on spreads today, said Gavan Nolan, analyst at Markit.

The euro zone periphery has been hit hard over the past year because of large debt.

(Additional reporting by Joanne Frearson and William James; Editing by John Stonestreet)

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