The local sharemarket retreated from a 4 1/2-year high yesterday before last-minute budget talks at the White House aimed at avoiding $US85 billion ($83bn) of automatic US spending cuts, the so-called sequester, which were due to take effect yesterday in the absence of a deal with congress.
In Asia, data showed that Chinese manufacturing weakened slightly in February, potentially renewing concern about momentum in Australia's biggest trading partner.
Investors were wary of any negative reaction to the sequester, which the Congressional Budget Office expects to subtract 0.6 per cent from the US economy this year.
The benchmark S&P/ASX 200 closed down 0.4 per cent at 5086.1 after surging 1.3 per cent on Thursday to its highest point since September 2008. The index was up 28 per cent since June, and 9.4 per cent this year.
Resources weighed on the market, with BHP Billiton, Woodside Petroleum, Rio Tinto, Newcrest and Fortescue Metals down between 0.6 per cent and 4 per cent after commodity price falls added to concerns about a late reversal of strength on Wall Street.
"Portfolio rebalancing contributed to Australian sharemarket strength yesterday and we are now seeing some caution before the US sequester, although a last-minute deal can't be ruled out," said IG market strategist Stan Shamu.
Barack Obama and congressional leaders were scheduled to meet overnight.
"That probably suggests there's some hope they will knock up a last-ditch deal in typical US government fashion," Mr Shamu said. "But the looming sequester does warrant some caution in Australian equities, particularly after the big run this year. If we don't get a deal, it could be a source of a near-term correction."
Westfield Retail Trust shares fell 4.1 per cent after the Lowy family sold its stake in the real estate investment trust for $663.7 million on Thursday.
Major banks outperformed, as JPMorgan upgraded Commonwealth Bank, ANZ Bank and National Australia Bank. CBA, Westpac and NAB rose between 0.7 per cent and 0.9 per cent.
Elsewhere in the financial sector, QBE Insurance jumped 2.2 per cent. Traders said US hedge funds were covering short positions after QBE unveiled a turnaround strategy in its 2012 results this week.
Ten Network surged 9.1 per cent on news Seven had accumulated just under 5 per cent of the free-to-air broadcaster.
Harvey Norman jumped 4.8 per cent after several analysts upgraded their ratings on the electronics, white goods and furniture retailer to neutral from sell.
The Australian dollar was lower as the US dollar strengthened broadly in the wake of more solid economic data from the world's largest economy.
At 5pm AEDT, the dollar was buying $US1.0236, down US0.4c.
Initial claims for US jobless benefits last week dropped to 344,000, compared with an expected 365,000.
