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* Nikkei, Topix down 0.5 pct * Nikkei may recover 10,600 if dollar/yen rises above 88-strategist * Mothers market strong, small-to-mid size shares up * Market cautious before earnings season -trader * Sharp rises, sees better-than-expected quarterly results By Ayai Tomisawa TOKYO, Jan 8 (Reuters) - Japan's Nikkei fell on Tuesday as investors turned cautious over the index's recent rapid gains and sold shares in exporters as the yen's depreciation paused, but falls were limited as ongoing optimism over future policy easing supported sentiment. The Nikkei dropped 0.5 percent to 10,548.56 by the midday break. Analysts said that investors took profits on some exporters' recent gains now that the weakening trend of the yen appears to have paused for the time being. The dollar traded at 87.60 yen, retreating from a 2-1/2-year high of 88.48 yen marked on Friday as robust appreciation over the past month had investors opting to book profits despite expectations of further Bank of Japan stimulus later in the month. "If the yen drops to 88 to the dollar, the Nikkei will likely recover the 10,600-line and even rise further," said Kenichi Hirano, a strategist at Tachibana Securities, adding that the market has stayed sensitive to daytime currency moves. Toyota Motor Corp shed 1.1 percent, Nissan Motor Co dropped 0.8 percent and Fanuc Ltd weakened 1.5 percent. On the other hand, small-to-mid size companies attracted buying as retail investors have come back to the market, said Hiroichi Nishi, general manager at SMBC Nikko Securities. The Mothers Exchange, which lists small-to-mid size companies, was up 0.8 percent after hitting the highest level since Sept. 2011 on Monday. CAUTIOUS MOOD BEFORE 3Q EARNINGS As the majority of companies start releasing their earnings for the Oct-Dec period mid to late this month, investors are growing cautious amid anticipation of sluggish growth in corporate profits, traders said. "Some stocks that have been rising won't see justifications to rise further such as industrial machinery makers and some autos as their third-quarter earnings are seen weak," said a trader at a foreign brokerage. "Broadly, people remain bullish but the market won't probably rise in a straight line." But he added that with expectations the central bank will come up with further stimulus measures, drops may be limited despite possible further corrections in the market. New Prime Minister Shinzo Abe, whose Liberal Democratic Party (LDP) surged to power in December's lower house election, has called on the central bank to take bolder monetary stimulus measures to beat deflation, and possibly hold it accountable not just for pushing up prices but also boosting job growth. A final decision will be made at the Bank Of Japan's next rate review on Jan. 21-22, when it will debate setting a higher inflation target than the current 1 percent goal. The Nikkei has risen about 22 percent since mid-November when Abe started calling for aggressive easing, taking the index deeper into overbought territory. Its 14-day relative strength index is at 75.22, above 70 which is considered overbought and often indicates an imminent adjustment. Sharp Corp bucked the overall market weakness and climbed 5.0 percent after the struggling TV maker said it had a better-than-expected operating profit for October-December, as it scrambles to generate profits in hopes of securing fresh financing. The broader Topix shed 0.5 percent to 877.04 in active trade, with 1.86 billion shares changing hands.