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Other Asian stock markets were also higher, but news of another fire at the earthquake-damaged Fukushima Daiichi nuclear plant north of Tokyo and fears of more radiation leaks kept investors on edge.

"The market doesn't care about any fundamentals today. All eyes are on the nuclear plant and the Nikkei will move according to the news about the plant," said Norihiro Fujito, a senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities.

Asian markets also received a filip from U.S. stocks, which closed down but off lows as a more upbeat view from the Federal Reserve helped limit Japan-related losses. The Fed stuck with its ultra-loose monetary policy but said the economy was gaining traction.

Tokyo's gains were led by short-covering by hedge funds, analysts said, adding that the market was still extremely volatile.

"The rebound is pretty strong as investors realized they may have panicked a bit too much yesterday," said Fujio Ando, senior managing director at Chibagin Asset Management.

"But it's mostly short covering by both domestic and foreign players, and not honest, active buying, because nuclear worries are still strong."

Japan's Nikkei average .N225 surged over 6 percent at one point, clawing back about a third of its losses since a massive earthquake and tsunami hit the country on Friday, but then slipped back below the psychologically important 9,000 point level.

By midday, it was at 8,981 points, up 4.37 percent. However, it was still down 12 percent from Friday's close. Osaka Nikkei futures were up 2.08 percent at 8.820.

Australian shares .AXJO were up around 0.5 percent, led by a relief rally in uranium producers Paladin (PDN.AX) and Energy Resources of Australia (ERA.AX), which had sunk on fears that many countries would scale back or suspend their nuclear power programs in light of Japan's woes.

Stock markets in South Korea .KS11, Taiwan, and Hong Kong .HSI were also up and the MSCI Asia-ex-Japan index .MIAPJ0000PUS was up 0.67 percent.

The yen slid to around 80.8 to the dollar, on fears of intervention by the Bank of Japan after the currency surged toward its 1995 historic high of 79.75. Speculators were betting that the Japanese government and companies would liquidate overseas assets to pay for reconstruction.

The euro was subdued after Moody's downgraded Portugal's ratings by two notches and was last down about 0.2 percent on the dollar for the day.

"Event risk is going to play a huge role in deciding what the yen does this week," UBS currency strategist Gareth Berry told Reuters Insider.

"The key thing to watch really is what happens to the Nikkei index in Japan and if equities rebound from their lows. That will help support risk appetite and that will lead to a slightly weaker yen.

The worst earthquake on record for the world's third- largest economy could have substantial ripple effects on the global recovery -- as evidenced by a sharp pullback in global equity prices, with Japanese stocks down over 10 percent.

But with the full impact still unclear, economists say the best thing for Fed officials to do at the moment may be nothing at all.

Even before the tragedy, U.S. central bankers faced confusing signals. Despite high unemployment, rising energy costs appear to be nudging up the price expectations of U.S. consumers, the first inklings of an inflationary psychology the Fed would like avoid.

"It's very tricky because calling out an increase (in expectations) would be a meaningful move in a hawkish direction," said Andrew Tilton, economist at Goldman Sachs.

At the same time, not acknowledging the recent pick-up seen in both market indicators and consumer surveys might make the Fed appear out of touch, eroding its inflation-fighting credentials.

In a statement due around 2:15 p.m. (1815 GMT), policymakers are likely to nod to recent improvement in the economy while seeking to avoid any suggestion that they intend to cut short a $600 billion bond-buying program announced in November.

Fed officials, who began their meeting at 8:30 a.m. (1230 GMT), will likely do so by beefing up their assessment of economic conditions while emphasizing just how far the central bank remains from its targets for both inflation and employment.

PROMISE AND WORRY

Since the Fed's last meeting in January, the U.S. economy has continued to show signs of promise. The U.S. unemployment rate has fallen rapidly, down to 8.9 percent in February from 9.8 percent in November.

Still, the pace of hiring suggests further progress will be painfully slow for the 8-million-plus Americans who lost their jobs during the economic slump of 2007-2009.

At the same time, higher gasoline costs have created fresh concerns for consumers, with a big hit to confidence this month raising concerns about whether a recent spurt in consumer spending can be sustained.

The U.S. economy expanded at an annualized rate of 2.8 percent in the fourth quarter, a respectable performance but one not seen fast enough to restore the job market to full health any time soon.

Some economists thought growth could approach 4 percent this quarter, but have pared back projections, in part because of an unexpected widening in the U.S. trade deficit.

The Fed chopped overnight interest rates down to effectively zero in December 2008 and since then has committed to buying a total of some $2.3 trillion in mortgage and Treasury securities to keep long-term borrowing costs down and support the recovery.

The yen tripped on talk of intervention and bond yields rose as investors sold debt to offset losses in the stock market. The scale and speed of the equity selloff, on record volume for a second day running, forced fund managers to sit on the sidelines.

"Even if we wanted to sell today there was very little we could do," said a fund manager at a Japanese fund, asking not to be named because he was not authorized to speak to the media.

"We didn't sell and waited sidelined because hedge funds were just dumping stocks in panic."

At one point the broader Nikkei plunged 14 percent after Prime Minister Naoto Kan said the risk of nuclear contamination was rising at the Fukushima Daiichi complex on Japan's ravaged northeastern coast, 240 km (150 miles) north of Tokyo.

Equity futures fell and the yen rallied as risky assets were dumped. The yen steadied soon after, raising suspicion that authorities had intervened. The Ministry of Finance declined to comment on intervention.

In contrast to Monday's trading, when construction stocks rose, none of the 225 constituents of the benchmark Nikkei average gained on Tuesday. The broad TOPIX index of Japanese stocks has dropped by 16.3 percent this week, the worst two-day losing streak since the global equity crash of October 1987.

"All focus is on the nuclear crisis. In the situation where the crisis appears to be worsening, foreign investors, domestic fund operators are pulling out from Japanese shares," Hideyuki Ishiguro, a supervisor at Okasan Securities in Tokyo.

The TOPIX share index plummeted 12.1 percent to 743.10, after posting the biggest full-day decline since the 2008 financial crisis on Monday on record volume.

The Tokyo Stock Exchange's biggest companies have lost about $626 billion in value this week. Volumes on the TSE first section were 5.77 billion shares, a nearly 20 percent increase from the record peak reached the previous day, itself the biggest since World War Two.

The Nikkei share average dropped 10.6 percent to 8,605.15, the biggest percentage loss since the global financial crisis of 2008.

During the trading day Japanese officials tried to calm the market to little avail and took measures to reduce short selling, such as placing limits on broker sales of stocks for arbitrage trading.

Shares of Tokyo Electric Power, the owner of the stricken nuclear plant, did not trade, although sellers massed at the indicated price of 1,221 yen on Tuesday. There were no buyers at that price.

The utility's credit default swap spreads, contracts that protect against debt default and restructuring, were at 190 basis points, exploding from 40 basis points on Friday and indicating nervousness about the company's future.

Since the quake, the Japanese government's CDS spreads have widened by around 35 basis points to 115 basis points, near the record 120 basis points reached in February 2009.

Tokyo's stock market plunged more than 14 percent as the stricken Fukushima nuclear power plant was hit by two explosions and a grim-faced Prime Minister Naoto Kan warned the nation that radioactivity levels had become "significantly" higher.

Even before Tuesday's dramatic events, economists had estimated that recovery and reconstruction costs would reach at least $180 billion, or 3 percent of the economic output of the world's third-biggest economy. Others suggested the cost could amount to 5 percent of output.

In the face of the country's biggest crisis since World War II, Japanese leaders urged calm.

"Japan's production and the economic power have not fallen. I think the market confusion will calm down in a short time," Economics Minister Kaoru Yosano said at a press conference.

Finance Minister Yoshihiko Noda said the market's fall was the response to "temporary factors."

The prime minister called for those within 30 km (18 miles) of the facility north of Tokyo to remain indoors, underscoring the worsening of Japan's nuclear crisis, the world's most serious since the Chernobyl disaster in Ukraine in 1986.

"There has been a fire at the No. 4 reactor and radiation levels in the surrounding area have heightened significantly. The possibility of further radioactive leakage is heightening," Kan said in an address to the nation.

"We are making every effort to prevent the leak from spreading. I know that people are very worried but I would like to ask you to act calmly."

Still, financial markets reflected a mounting fear about the radiation risk in a country already reeling from the quake and tsunami.

The Fukushima nuclear power plant at the center of the crisis, operated by Asia's biggest utility Tokyo Electric Power Co, is 240 km (150 miles) north of Tokyo, the political and commercial heart of the country.

TEPCO shares have hardly traded as sell orders flooded the market. But at the close of trading on Tuesday, it was down 42 percent from its Friday close.

MARKETS TUMBLE

The Nikkei fell as much as 14 percent at one stage, before closing down 10.5 percent, its biggest percentage fall since October 2008 during the height of the financial crisis.

At the lows of the day, the market had lost a fifth of its value since Friday.