Hong Kong (AFP) - Japanese shares rallied Thursday as the yen extended losses after the new prime minister dampened interest rate hike expectations, while Hong Kong sank for the first time in more than a week after a blistering China-fuelled surge.

Traders remain on edge, however, as they await Israel’s response to Iran’s missile attack on Tuesday, which has fanned fears of a regional conflict in the Middle East, pushing oil prices ever higher.

The Nikkei gains come after a rollercoaster few days in Tokyo that followed Prime Minister Shigeru Ishiba saying the time was not right for further increases in borrowing costs after a meeting with central bankers.

News of Ishiba’s victory in a ruling party vote last Friday – essentially making him premier – sent the yen soaring and stocks plunging at the start of this week as he had previously spoken of his backing for the Bank of Japan’s policy tightening.

The country’s currency and stocks have since fluctuated, but his remarks late Wednesday appeared to quash the chance of a third hike this year.

“I don’t think we are in the environment for further rate hikes,” Ishiba told reporters after meeting with BoJ boss Kazuo Ueda.

“The economy will continue to develop sustainably while maintaining an easing trend. The economy will continue to move toward ending deflation. That’s the hope I expressed to the governor.”

The BoJ lifted rates in March for the first time in 17 years as it moved away from its long-running ultra-loose monetary policy. A surprise second lift in July sparked turmoil in markets.

Ishiba’s remarks sent the yen tumbling to 147.24 per dollar Thursday, its weakest since August, having sat around 143 the day before. In response, the Nikkei jumped more than two percent as exporters – who benefit from a cheaper currency – rallied.

Shares in Hong Kong sank more than two percent on profit-taking after soaring more than 20 percent since China last Tuesday began unveiling a raft of economy-boosting measures.

The stimulus, which has a big focus on supporting the embattled property sector, has renewed interest in Hong Kong and mainland Chinese markets, which had also seen blistering gains before closing for a weeklong holiday on Monday.

“Judging from the turnover in the market, it certainly suggests that the participation has widened quite significantly compared to the beginning of the year,” said Jason Lui, head of APAC equity and derivative strategy at BNP Paribas.

“One of the reasons we think China-Asia has been so depressed until recently is because of the dramatic decline in turnover.

“Since March, we have seen a 45 percent decline in average daily turnover into early September, and then that has changed over the past one or two weeks.

“So judging from the increase in turnover, I think it’s reasonable to assume that you now have a different investor base coming in to participate in the equity market.”

Other Asian markets rose, with Sydney, Singapore, Wellington, Manila and Jakarta all in the green.

Oil prices rose around one percent as debate swirls around what Israel will do after Iran fired scores of missiles at the country and as it carries out military operations in Lebanon.

Prime Minister Benjamin Netanyahu vowed to make Tehran pay for its “big mistake”, while Iran threatened to hit all Israeli infrastructure if attacked.

Investors were given a tepid lead from Wall Street even after a forecast-beating rise in US private-sector jobs.

The reading came ahead of the closely watched non-farm payrolls figures Friday, which could have a bearing on the Federal Reserve’s thinking on whether or not to cut rates again this month and if so by how much.

- Key figures around 0230 GMT -

Tokyo - Nikkei 225: UP 2.2 percent at 38,655.03 (break)

Hong Kong - Hang Seng Index: DOWN 3.3 percent at 21709.85

Shanghai - Composite: Closed for a holiday

Dollar/yen: UP at 146.90 yen from 146.38 yen on Wednesday

Euro/dollar: DOWN at $1.1037 from $1.1048

Pound/dollar: DOWN at $1.3253 from $1.3266

Euro/pound: UP at 83.28 pence from 83.26 pence

West Texas Intermediate: UP 1.1 percent at $70.88 per barrel

Brent North Sea Crude: UP 1.0 percent at $74.62 per barrel

New York - Dow: UP 0.1 percent at 42,196.52 (close)

London - FTSE 100: UP 0.2 percent at 8,290.86 (close)