Tokyo's benchmark index lost ground despite news of the rate-cut
The Bank of Japan has cut its main interest rate from 0.5% to 0.3% - its first reduction for seven years.
The move followed a global wave of rate cuts to contain the financial crisis. Japan has the lowest interest rates in the developed world.
Tokyo's benchmark Nikkei index briefly inched up following the news, but it ended the day down 5%.
On Thursday, Japan announced a five trillion yen ($51bn; £31bn) economic package to boost its flagging economy.
A soaring currency and the slowdown in Europe and the US have put Japanese exporters under severe strain in recent weeks.
In a vote on whether to lower interest rates, the Japanese central bank's monetary policy board was evenly split, so the final decision was taken by governor Masaaki Shirakawa.
Analysts said some investors were unhappy that the bank had not cut rates further. There had been hopes that the bank would reduce rates to 0.25%.
The Nikkei ended down 453 points at 8,577.
Tax cuts and benefits
Explaining its decision to cut rates, the Bank of Japan said the impact of the global financial crisis had "further increased in severity".
"Increased sluggishness in Japan's economic activity will likely remain over the next several quarters with exports levelling off and the effects of earlier increases in energy and materials prices persisting," it added.
Thursday's economic stimulus package, which was unveiled by Prime Minister Taro Aso, was the country's second in as many months.
It came after an 11.7 trillion yen package unveiled in August by Mr Aso's predecessor, Yasuo Fukuda.
As well as cutting highway tolls and increasing loan guarantees that have been offered to small companies, there will be tax cuts and other benefits for Japan's struggling households.
The new package includes an expansion of tax-exempt housing loans to boost the struggling property market, funding for care of children and the elderly, and support for unemployed young people.