In the face of Japan's sharpest and most destructive recessionary plunge in living memory, its central bank has cut interest rates back down to nearly zero and unleashed a salvo of measures to fix its broken credit markets.

In a move that highlights the severity of the country's woes, the Bank of Japan has effectively taken the nation back into the familiar territory of “quantitative easing” - the policy that it previously adopted to drag the economy out of its protracted slump.

Additional measures are likely to include the purchase of as much as Y20 trillion (£145 billion) of shares from the bloated portfolios of the banking sector.

In what investors interpreted as an “all-out” attempt by Japan to match the US Federal Reserve's aggressiveness, the central bank said that as well as stepping up purchases of government bonds from the banks, it would take the drastic step of beginning outright purchases of the commercial paper of corporate Japan - a move designed to thaw an acute funding freeze that is pushing thousands of companies to the brink of crisis.

Although many analysts viewed the rate cut as far less significant than the quantitative easing measures, the perceived delicacy of the situation was clear from the central bankers' language.

Masaaki Shirakawa, the Governor of the Bank of Japan, said the rate cut was “aimed at stimulating the economy”, but added that the rate had not been lowered further “to avoid the short-term money market from ceasing to function”.

The drop in rates, which haul Japanese central bank policy back to the “lost decade” of the 1990s, comes as many of the country's old demons have returned to haunt the world's second-biggest economy.

Economists in Nomura Securities gave warning that Japan would probably find itself once again in the nightmare of deflation by the middle of next year.

The cut in the BoJ's key policy rate from 0.3 per cent to just 0.10 per cent was made partly in response to the prolonged surge in the yen - a move that has annihilated the international competitiveness of Japanese exports and carved huge holes in the profitability of its largest companies.

The yen recently touched a 15-year high against the dollar, and was yesterday trading at Y89 to the US currency, and IT has surged against the euro and the pound in recent months.

Before the rate cut was announced, Japanese awoke to alarming reports that Toyota would probably end fiscal 2008 with its first full-year loss in its 70-year history. Toyota's efficiency is legendary and the prospect of seeing its first red ink deals a crushing blow to confidence within Japan Inc.

The BoJ's cut came along with yet more downgrades in the central bank's outlook for the coming year. Officials are now using the word “deteriorating” for the first time since 2002.

Although the rate decision mirrors this week's move by the Fed, the direction of the quantitative easing measures point to what analysts said were more troubling signs from the corporate sector: the US authorities are expanding the central bank's balance sheet to support the financial sector, while Japan is doing the same to support everything from electronic component makers to restaurant chains.

After staring over the precipice six years ago, Japanese financial institutions embarked on a period of painful deleveraging that ended only in 2005. In the current crisis, their funding issues are accordingly less dire than those of the corporate sector.

Naomi Fink, Japan strategist for the Bank of Tokyo Mitsubishi UFJ, sounded a note of caution over the rate cuts, which effectively deprive Japanese households of about Y1.5trillion in interest income.

Amid predictions that individual Japanese investors were set to become net buyers of their own market, money that appeared primed to flow into Japanese stocks for the first time in 18 years may now not do so.

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