Ueda had six birdies and one bogey at the 6,506-yard, par-72 Kintetsu Kashikojima Country Club to finish at 7-under 137.
'I'm satisfied with the way I played today,' said Ueda, who took a week off before this tournament.
Davies looked set to maintain her lead but had a double bogey on the par-4 14th, and had to settle for a 72.
On 14, Davies was given a two-shot penalty for putting from the wrong place.
'I could have a three, four-shot lead right now quite easily, which is just rotten really,' Davies said. 'I didn't make another birdie coming in, and now I'm tied for the lead instead of being two, three, four ahead. Very, very disappointed.'
Davies, who had a one-stroke lead after the first round, is bidding for her first win in Japan since taking the Itoen Ladies title for a fourth time in 2001.
American Reilley Rankin, Sweden's Maria Hjorth and Japan's Mie Nakata are one stroke back of the leaders.
Australian Karrie Webb, who came from behind to snap Annika Sorenstam's Mizuno Classic winning streak at five here last year, struggled and is tied for 61st after a 76. Sorenstam is taking the week off.
The $1.4 million tournament has a first prize of $210,000.