Government stimulus and vigorous exports propelled Japan’s economy unexpectedly higher in the third quarter, though the government is believed to be just hours away from declaring officially that the country has again fallen prey to deflation.

Gross domestic product (GDP) growth in the world’s second biggest economy – a status Japan is expected to cling onto for only another few months before losing the title to China – was 1.2 per cent stronger than in the previous quarter. That translates to a 4.8 per cent annualised pace of growth and Japan’s second consecutive quarter of growth after its emergence from recession earlier this year.

The rise in Japan's GDP — which is a key measure of a country's economic health — takes the annual increase to 4.8 per cent, ahead of the 2.7 per cent gain recorded in the year to June and the strongest rate in two and a half years. Of the world's leading economies, only Britain remains in recession.

Last week, the eurozone emerged from recession after five successive quarters of contraction, fuelled by Germany and France which both revealed rising GDP for the third quarter after emerging from recession in the second three months of the year. Both America and China have also exited recession.

In Japan, the surge in GDP, said analysts, showed that while the country had led the developed world into recession, it was also leading the way out. The more cheerful set of growth numbers emerged amid continuing agitation in the market over the future of Japanese government bonds and what some believe could portend a sovereign default.

But the domestic demand deflator plunged 2.6 per cent from the previous year - its steepest decline for just over half a century. That triggered Cabinet Office deliberations over whether the time had come to declare Japan back in deflation.

The threat of Japan’s return to its deflationary nightmare of falling prices and, critically, price expectations, delivered a flat session on the Tokyo Stock exchange despite the day’s surprisingly upbeat growth figures. It was Japan’s long and frustrating struggle to shrug-off deflation in the 1990s that generated the concept of a “lost decade”.

Continuing stimulus efforts by Japan’s new government have succeeded in making some consumers feel happier about spending, though Richard Jerram, chief Japan economist at Macquarie Securities said that the composition of Japan’s GDP had now improved. Exports still contributed substantially to growth, but private domestic demand swung significantly from negative to positive territory.

The government also appeared keen to downplay the strength of Monday’s report and indicated that the new growth rate would not cause any pull-back on state efforts to stimulate the economy.

"There is no change in the severe condition of the country's economy," said deputy prime minister Naoto Kan, We are concerned about whether the economy falls into a deflationary situation,"

Retail analysts have been remarking for some time that Japanese spending patterns have taken a dramatic shift to the thrifty. Cheap clothing stores like Uniqlo have performed staggeringly well in the newly parsimonious environment, while some of the world’s largest luxury brands have either scaled-back their Japanese operations or, like Versace, closed them altogether.

Analysts at Nomura took Monday’s numbers as an opportunity to raise their estimates for real GDP growth in 2009 and 2010. The securities house now expects a contraction of -2.6 per cent in the current fiscal year, but 1.1% positive growth after that.

“We expect that after strong recovery through to the end of this year, the Japanese economy will see growth turn down in reaction to rapid yen appreciation and the fading impact of stimulus measures,” wrote their chief economist in a note to investors.

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