The decision reflects the total release of radiation at the damaged Fukushima Daiichi power plant, which is ongoing, rather than a sudden deterioration.
Level seven previously only applied to the 1986 Chernobyl disaster, where 10 times as much radiation was emitted.
Meanwhile a 6.0-magnitude earthquake on Tuesday prompted the plant's operator to evacuate its staff.
Tokyo Electric Power Co (Tepco) said it was checking the status of the plant after the quake, the second to hit in as many days, but said there had been no reports of problems with external power.
The aftershocks come a month after a huge quake and tsunami hit north-east Japan, leaving 13,219 people dead and 14,274 missing. More than 150,000 people have been made homeless.Impact of leaks
An official from the Nuclear Safety Commission of Japan announced that the crisis level at the Fukushima Daiichi plant was being raised in a televised statement, adding that it was a preliminary assessment that was subject to confirmation by the International Atomic Energy Agency (IAEA).
The level seven signifies a "major accident" with "wider consequences" than the previous level, officials say.Continue reading the main story Rachel Harvey BBC News, Tokyo
On the face of it this reclassification from a level five incident to a level seven is an alarming jump.
But the change has not been made because things have suddenly got worse at the Fukushima plant. Rather, a full assessment of the available data now suggests that a higher rating is justified.
Although the Japanese incident now equates to Chernobyl on the international scale, the two accidents are different in a number of important ways. In Chernobyl it was the reactor core itself that exploded, releasing a huge amount of radioactive material in a very short space of time. Fukushima experienced a less critical hydrogen explosion.
The initial radiation leak amounted to about a 10th of that which escaped from Chernobyl. The major concern in Japan is that the nuclear plant has not yet been brought under control, and some radioactive material is still seeping out."We have upgraded the severity level to seven as the impact of radiation leaks has been widespread from the air, vegetables, tap water and the ocean," said Minoru Oogoda of Japan's Nuclear and Industrial Safety Agency (Nisa), the government's nuclear watchdog.
One official from Tepco said that radiation leaks had not stopped completely and could eventually exceed those at Chernobyl, Reuters news agency reported.
However, a nuclear safety agency spokesman told reporters the leaks were still small compared to those at the plant in Ukraine, then part of the Soviet Union.
"In terms of volume of radioactive materials released, our estimate shows it is about 10% of what was released by Chernobyl," he said.
The decision to raise the threat level was made after radiation of up to 630,000 terabequerels per hour had been estimated at the stricken plant for several hours.
That would classify the crisis at level seven on the International Nuclear and Radiological Event Scale (Ines).
It was not clear when that level had been reached. The level has subsequently dropped to less than one terabequerel an hour, reports said.
In comparison the Japanese government said the release from Chernobyl was 5.2 million terabecquerels.Evacuations extended
The severity level of Japan's nuclear crisis had previously been set at five, the same as that of the accident at Three Mile Island in the US in 1979.Continue reading the main story Level 7: Chernobyl, Ukraine, 1986 - explosion and fire in operational reactor, fallout over thousands of square kilometres, possible 4,000 cancer casesLevel 7: Fukushima, 2011 - tsunami and possibly earthquake damage from seismic activity beyond plant design. Long-term effects unknown Level 6: Kyshtym, Russia, 1957 - explosion in waste tank leading to hundreds of cancer cases, contamination over hundreds of square kilometresLevel 5: Windscale, UK, 1957 - fire in operating reactor, release of contamination in local area, possible 240 cancer casesLevel 5: Three Mile Island, US, 1979 - instrument fault leading to large-scale meltdown, severe damage to reactor coreJapan has also said it is extending the evacuation zone around the crippled nuclear plant because of radiation concerns.
The zone will be widened to encompass five communities beyond the existing 20-km (12-mile) radius, following new data about accumulated radiation levels, officials said.
Japan's nuclear commission said that according to preliminary results, the cumulative level of external radiation exceeded the yearly limit of 1 millisievert in areas extending more than 60km (36 miles) to the north-west of the plant and about 40km to the south-southwest.
On Monday, a 7.1-magnitude quake hit north-east Japan, leaving three people dead. It also triggered a brief tsunami warning, and forced workers to evacuate the Fukushima Daiichi plant.
Tuesday's quake rocked buildings in the capital, Tokyo.
There were no immediate reports of fresh damage, though Japan's Narita international airport temporarily closed its runways, and metro and train services were interrupted.
The cooling systems at the Fukushima Daiichi nuclear plant were damaged in last month's disaster and workers have been struggling to prevent several reactors from overheating.
Officials have warned it will be several months before the situation at the nuclear facility is brought fully under control.
Tepco said on Tuesday that a fire had broken out briefly at Reactor 4, before being extinguished.
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