The Japanese economy, the world’s second largest and a bellwether for corporate and consumer strength across the globe, has officially fallen into recession, its Government admitted this morning.

The second straight quarter of economic contraction confirmed what most investors already knew: that Americans and Europeans have stopped buying cars and electronics and that Chinese factories have stopped purchasing industrial machinery. The Nikkei rose 0.7 per cent as investors bought cheap stock.

The Government’s grim assessment of Japan’s outlook came amid mounting evidence that the country’s most famous corporate names are struggling as the financial crisis spreads into the real economy.

Toyota is poised to start offering zero per cent financing in Europe to match a similar system in place in the US. Sharp is to cut LCD television production at its largest plant and, over the weekend, the real estate sector suffered another high-profile bankruptcy.

Lurking among the government figures was the number that many had dreaded. The main gauge of inflation dropped 1.6 per cent from a year earlier, suggesting that Japan is once again confronted by deflation — a monster that took the Bank of Japan and the Government nearly a decade to defeat.

Analysts are also predicting a drop in winter bonuses throughout corporate Japan, which is traditionally a useful guide to the direction of consumer spending.

Although the market was well prepared for the headline recession news, the rate of economic decline in Japan was worse than most analysts had feared: their consensus forecasts expected growth to be flat, rather than contracting.

Japan’s economy shrank by 0.4 per cent in real terms, which corresponded to a 0.1 per cent drop in GDP between the first and second quarters of the financial year.

Having resisted declaring a recession for several months, Kaoru Yosano, Japan’s Fiscal Policy Minister, acknowledged that the GDP numbers “showed that we have entered a recessionary phase” and gave warning that the continuing problems for the global economy would ensure that “downward movements in Japan are expected to continue.”

Japan’s plunge into recession came despite a modest 0.3 per cent rise in domestic consumer spending — an economic force which accounts for just over 55 per cent of Japan’s GDP. Corporate capital spending was also on the rise, up 1.7 per cent.

Economists at Mitsubishi UFJ Securities said that the weakening outlook for capital spending was a bad sign for Japan, and that rising inventories in the corporate sector would trigger a sharp acceleration in production cuts in the coming quarter.

Meanwhile, there were further signs that the rate of growth of the Chinese economy may be slackening.

The China National Petroleum Corporation said the country's demand for oil was slackening, and stockpiles of crude and oil products were rising. China's economic growth slowed to nine per cent in the third quarter, the lowest level in more than four years.