The world's second biggest economy may be teetering on the brink of what the Japanese call kansei fukyo — a “recession brought about by government policy error” that has crushed activity in the construction sector and is driving many small firms into bankruptcy.

The warning, issued by a senior economist at Morgan Stanley, came as the Government of Japan unexpectedly slashed its growth forecasts for the current fiscal year because of the ill effects of its own recently enacted laws.

Morgan Stanley's Takehiro Sato added that there was now even a view that Japan might revert to zero interest rates — the unorthodox and much criticised monetary policy to which the Bank of Japan (BoJ) clung for six years and which the country only relinquished 18 months ago.

Sustained high oil prices, a resurgent yen and tumbling equity markets could force such a move, Mr Sato said. With food and energy prices rising fast, frozen Japanese wages could force the BoJ to cut rates in a cycle of price-led inflation.

Although the BoJ is expected to keep interest rates on hold at its monetary policy meeting today, the collapse of the housing and construction market is expected to weigh heavily.

The Cabinet Office said yesterday that GDP growth to March 2008 would be just 1.3 per cent, down from 2.1 per cent.

The contraction follows a the introduction of a poorly explained building standards law, the impact of which is leading to forecasts that housing investment will plummet 12.7 per cent in the current year.

The law was made after a 2005 scandal in which earthquake-proofing data was fabricated.

It has already triggered bankruptcies among small construction firms and is viewed by many as an over-reaction to the original crime.

Consecutive months of double-digit falls in housing-start numbers have also followed.

Lehman Brothers has said the damage to the construction sector may be semi-permanent.

Another law, which curbs consumer finance companies' ability to set lending rates, has affected consumer spending levels, while rules that force one-hour “risk explanations” on any would-be buyers of investment trusts have also badly dented their sales.

Sundown

1.3%
Revised forecast of GDP growth to March 2008

2.1%
Government's previous forecast

15030
Yesterday's Nikkei 225 Index close, less than 400 points above its low for the year

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