Japan Heads for Worst Recession Since the Second World War

Japan could be heading for its worst recession since the war after figures released today showed industrial output fell almost 10% last month and unemployment rose at its fastest pace for more than 40 years.

Production fell 9.6% in December, the trade ministry said, surpassing even November's huge drop by more than a percentage point.

The global recession has sent shock waves through Japan's economy, forcing once powerful exporters to rein in production, slash jobs and close factories in response to plummeting demand for cars and consumer electronics.

Today's figures, however, offered evidence that the malaise has spread to the domestic economy.

Unemployment rose to 4.4% in December, its biggest monthly rise for 42 years, from 3.9% a month earlier. The jobless total has risen over the last year by 390,000 to 2.7 million, as the specter of deflation and flat consumer spending return to haunt companies and their employees.

Household spending fell by 4.6% in December, the tenth consecutive monthly fall, while core consumer inflation edged up a mere 0.2%.

"Companies are not only cutting production but also cutting employment, which is deeply unsettling for households," Martin Schulz, senior economist at the Fujitsu Research Institute, told guardian.co.uk.

"We are now looking at a domestically driven recession. The domestic economy is at risk of falling apart, and if that happens we are looking at a really deep, long recession. Even if that doesn't happen, things are already bad enough."

With Japan's non-regular employees, who now comprise a third of the workforce, at increasing risk of being laid off, families are simply refusing to spend and analysts say the government's much-derided handout of ¥12,000 for every individual is unlikely to have any impact.

Predictions of further falls in production in the coming months are making prime minister Taro Aso's boast that Japan will be the first to emerge from the recession look increasingly hollow.

The economics minister, Kaoru Yosano, admitted the economy was "in a very grave situation."

"Japan is being hit by a wave of weakening global demand," he said.

The plight of Japan's exporters was underlined yesterday when Toshiba forecast record annual losses. Toyota, meanwhile, could be heading for an operating loss - its first for more than 70- years - of about ¥400bn for the year through to the end of March, reports said today, while Sony is bracing itself for record losses this year.

Although factory production is at its lowest level in 20 years, cuts in output have barely dented bloated inventories, prompting speculation that even more reductions could be around the corner.

Exporters' desperate attempts to climb out of the crisis are being hampered by the strength of the yen, which gained 23% against the dollar and 29% against the euro last year.

Economists predict that fourth-quarter GDP figures, due out next month, would show the world's second biggest economy is shrinking at a double-digit annual rate.

In addition the International Monetary Fund warned that Japan's GDP would contract by 2.6% this year, the gloomiest prediction of all the G7 countries except Britain. If the IMF forecast is correct, it would be the worst contraction since the end of the second world war.

"As output adjustments continue, weakness in the overall economy will persist from January to March, and the degree of worsening depends on how exports turn out," said Tatsushi Shikano, senior economist at Mitsubishi UFJ Securities.

"It is already a consensus view that core consumer inflation will turn negative soon, but we must watch if a worsening of the economy pushes Japan into a deflationary spiral, even though the Bank of Japan sees no signs of that happening right now."

The gloomy data stopped in its tracks a three-day rally by the Nikkei, sending the benchmark index tumbling 3.1% in Tokyo.

Nintendo shares sank 12% after the video game maker cuts its earnings and sales forecasts. The company, which had enjoyed huge sales of its DS and Wii game consoles, said yesterday that annual operating profit would fall by 16%. Honda, Toyota, Sony and Toshiba were also down.

The Nikkei has lost more than 10% already this year after shedding more than 40% last year.

The Bank of Japan is buying up corporate debt and recently brought interest rates down to just above zero, while the government this week passed a US$53bn stimulus package and launched a US$16.7bn fund to buy shares in struggling firms.

But Schulz said Japan's financial authorities were running out of options to save the economy from a deeply damaging recession.

"The government has few tools left to deal with this. Japan managed to shield failing companies during the last recession – the so-called zombie firms – but you cannot protect companies from a breakdown in demand in the domestic economy."