Japan returned to deflation for the first time in two years, as the Japanese economy contracts sharply in the face of the global economic downturn.

The country's core inflation measure, which excludes oil prices, fell back 0.1 per cent in March, the first decline since late 2007.

Although the figure was less than the 0.2 per cent forecast by economists, deflation is expected to be back for some considerable time.

The Bank of Japan has forecast that deflation — which Japan had been suffering from for most of the decade — will be back for another two years.

Deflation damages the economy because consumers hold back from purchasing decisions, as they wait for cheaper prices, and companies cannot easily boost profits.

The country's "core-core" index, which also excludes fruit, vegetables and seafood as well as oil because of their volatile pricing, fell back by 0.3 per cent.

At the same time, the unemployment rate increased to a four year high of 4.8 per cent, and the number of jobs on offer fell to a seven-year low with only half as many jobs as applicants.

The number of jobless people has jumped 670,000 in the space of a year — matching a record rise a decade ago — and poses a problem for Taro Aso's government, which faces an election this year.

Japan’s economy slumped 3.2 per cent in the fourth quarter, the biggest decline in 35 years, according to previously released data, and an even bigger contraction is forecast for the first quarter.

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