Why can some ASCII characters not be expressed in the form ‘\uXXXX’ in Java source code?

Unicode characters are replaced by their value, so your line is replaced by the compiler with:

char error="
";

which is not a valid Java statement.

This is dictated by the Language Specification:

A compiler for the Java programming language (“Java compiler”) first recognizes Unicode escapes in its input, translating the ASCII characters \u followed by four hexadecimal digits to the UTF-16 code unit (§3.1) of the indicated hexadecimal value, and passing all other characters unchanged. Representing supplementary characters requires two consecutive Unicode escapes. This translation step results in a sequence of Unicode input characters.

This can lead to surprising stuff, for example, this is a valid Java program (it contains hidden unicode characters) – courtesy of Peter Lawrey:

public static void main(String[] args) {
    for (char c‮h = 0; c‮h < Character.MAX_VALUE; c‮h++) {
        if (Character.isJavaIdentifierPart(c‮h) && !Character.isJavaIdentifierStart(c‮h)) {
            System.out.printf("%04x <%s>%n", (int) c‮h, "" + c‮h);
        }
    }
}