The Japanese economy has plunged into the double nightmare of runaway deflation and soaring joblessness, dealing probably a decisive, fatal blow to the ruling Liberal Democratic Party (LDP) as it fights its most desperate battle for political survival in 50 years.

The unemployment rate hit a record 5.7 per cent in July, although many analysts believe that the official number could gravely understate the true extent of Japanese joblessness. Sources within the Government believe that its calculation methods, which exclude millions of men and women not looking for work from the unemployment register, may disguise a figure twice the official size.

Analysts at Nomura have warned of Japan’s huge hidden jobless problem and of the likelihood that the true extent of the crisis may yet emerge more clearly. In one scenario, unemployment in Japan could reach 12.2 per cent as companies shed armies of surplus labour, Takehide Kiuchi, the bank’s economist, said.

The two reports published on Friday — July unemployment numbers were accompanied by the latest figures for the consumer price index — paint a particularly dismal picture of the world’s second-biggest economy, only days after official GDP numbers had showed Japan crawling out of technical recession.

One of the LDP’s few credible campaigning points has been that, as the party in charge during Japan’s phase of mega-growth in the 1970s and 1980s, it has the knowhow to guide the country back to prosperity: that claim, voters on the streets of Tokyo said last night, has crumbled to dust.

“I don’t know what the [main opposition] DPJ is going to do to stop my customers deserting my shop,” Asuka Sato, a 25-year-old nail salon beautician, said. “All I know is that nobody could ever be as bad for the economy as the LDP has.”

Consumer prices nosedived 2.2 per cent year-on-year in July, the most acute fall that they have logged, surpassing even the drops endured during the country’s five-year struggle with deflation that began in the late 1990s.

Indeed, it is hard to see any positive signals, Naomi Fink, a strategist at the Bank of Tokyo Mitsubishi UFJ, said: “The rising rate of unemployment evidences the glaring inadequacies of the Japanese stimulus package, which has clearly created an insufficient number of jobs to combat the effects of the crisis and thus had insufficient effect on consumption,” she said.

Takuji Aida, an economist at UBS, said that although the price declines were largely the product of falling energy prices, the core figures were a reflection of weak demand in the service sector and the trend would have a big impact on employment figures.

Fear of yet more rounds of job cuts have crept across the Japanese economy. Toyota’s announcement this week that it would close permanently one of its domestic car production lines confirmed for many that those worries were justified. Thus households have made abrupt cuts in their spending: cheap clothing stores and discount food wholesalers have been doing well, while the retail mainstream has suffered.

Although Japan broke free of its long cycle of economic contraction in the most recent quarter, few believed that it was time to start celebrating a recovery. The stock market may have continued a long rally, but many economists warned that trading floor euphoria was not a reflection of Japan’s true prospects and that falling prices would exact the same heavy toll that they did during Japan’s last phase of deflation.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive