Japan has slumped into its third recession in a decade and the economy is set to deteriorate further as prices slide and unemployment rises amid weak consumer demand and the global slowdown, the government said on Friday. The dollar surged to a four-month high against the yen as the bad news was digested, dealers said.
Gross domestic product (GDP) in the three months ended September fell 0.5 per cent from the previous quarter, when the world`s second largest economy shrank a revised 1.2 per cent.
Two consecutive quarters of contraction are widely defined as recession.
"The US economy is experiencing negative growth at the moment and it is quite possible that we will see a severe figure for October-December," State Minister for Economic and Fiscal Policy, Heizo Takenaka told a news conference in Tokyo. The dollar rose to 125 yen at 3:00 pm (0600 GMT) up from 124.65-68 yen in Tokyo late on Thursday.
"The headline figure confirmed Japan was bad, but when you look at the details you can see it`s dreadful," said a foreign exchange manager at Barclays Capital. The dollar last broke the 125-level on August 1.
On an annualised basis, Japan`s economy shrank 2.2 per cent during the three months to September and 4.8 per cent in the June quarter.
Takenaka referred to a "fear economy", with the Japanese reluctant to spend due to concerns about their prospects as unemployment rises to unprecedented heights. "Households seem more concerned about the future than we expected," the minister said.
Consumer spending, which accounts for two-thirds of Japan`s GDP, sank 1.7 per cent over the quarter, the sharpest slide since the end of 1999, due to rising unemployment and wage cuts.
Japan`s jobless rate climbed to a record high of 5.4 per cent in October and most economists expect the level to hit six per cent by next year. Lay-offs and wage reductions were being implemented faster than the government had expected, said Takenaka.
In the past month, hi-tech leaders such as NEC Corp and Hitachi Ltd have accelerated restructuring plans which include cutting the jobs of over 100,000 workers. The financial sector is also reducing staff with most major banks suffering losses as they speed up bad loan write-offs and the value of their share portfolios sink.
The September 11 terrorist attacks in the United States and the discovery of mad cow disease at home further chilled consumer sentiment, economists said.
Capital spending by the private sector rose 1.1 per cent over the quarter, led by investment in information technology but a global slump in demand for hi-tech products will depress future spending, said UBS Warburg chief economist, Hiromichi Shirakawa.
Public investment also grew 3.2 per cent over the three month period but this will subside as the government reins in spending to contain the national debt, which has ballooned to 130 per cent of GDP, economists said.
Takenaka said the government was committed to implementing its reform drive -- despite fears it would further chill the economy -- which includes a clean up of the banking sector, a cap on new government bond issues and a more efficient allocation of budget spending. Prime Minister Junichiro Koizumi has called for a relatively slim 4 trillion-yen ($ 33 billion) second extra budget to take total supplementary spending this fiscal year to 7 trillion yen.
But some analysts and lawmakers argue the amount will be insufficient to offset the onset of a depression.
Takenaka told reporters that Japan should retain a revised forecast for current fiscal of a 0.9 per cent economic contraction, but warned of the risk of intensifying price falls.
"Japan is now at the entrance of a deflationary spiral and there is a risk of falling into it, but it has not done so yet," Takenaka said.
The stock market largely shrugged off the data, although weak sentiment pushed the Nikkei-225 average down 0.6 per cent to 10,796.89.

Bureau Report