Japan – the world’s second-largest economy and a bellwether for corporate and consumer strength worldwide – has become the latest leading industrial power to lurch into recession.

The country’s second straight quarter of economic contraction confirmed what most investors already knew: that Americans and Europeans have stopped buying cars and electronics and that Chinese factories are cutting back on buying machinery.

Corporate Japan loses billions of dollars in profits with each upward surge of the yen against the dollar. Because the yen was the favourite “carry” currency, borrowed to fund investment speculation around the world, a huge deleveraging spasm by hedge funds has given the yen a dramatic boost against the greenback and has savaged company earnings across the board.

Although the market was well prepared for the headline recession news yesterday, the rate of economic decline in Japan was worse than most analysts had feared: their consensus forecasts expected growth to be flat, rather than contracting.

Japan’s economy shrank by 0.1 per cent in the quarter to September 30, against the same period a year earlier, or by 0.4 per cent on an annualised basis. It shrank by 0.9 per cent in the preceding three months. Two consecutive quarters of economic contraction is the widely accepted definition of a recession.

Glenn Maguire, chief Asia economist at Société Générale, said that Japan’s latest recession differed from the ones that characterised the country’s “lost decade” in the 1990s because it was cyclical, rather than structural. Investors, he said, should watch closely the performance of “old Japanese” industries, such as steel and chemicals, with high exposure to China’s investment cycle.

Having resisted declaring a recession for several months, Kaoru Yosano, Japan’s Fiscal Policy Minister, acknowledged that the GDP numbers “showed that we have entered a recessionary phase” for the first time since 2001 and said that continuing problems for the global economy would ensure that “downward movements in Japan are expected to continue”.

Cameron Umetsu, an economist at Nomura, said that the key question now was how deep and how long Japan’s recession would be. Optimists, he predicted, would cling to the idea of a shallow downturn that is relieved both by the eventual recovery of China and emerging markets in Asia, and Japan’s own Y27 trillion (£190 billion) government stimulus package. Present levels of employment in Japan, he added were “not at bloated levels that would portend an economic collapse”.

But none of that, Mr Umetsu said, should obscure the fact that Japan would remain far less sensitive to domestic policy initiatives than global demand and exports. “There is little reason for optimism in an environment where global growth momentum is clearly slowing and should deteriorate further next year,” he said.

Lurking among the government figures was the number that many had especially dreaded. The main gauge of inflation dropped by 1.6 per cent from a year earlier, suggesting that Japan is once again confronted by deflation – a monster that it took the Bank of Japan and the Government nearly a decade to defeat and which came to symbolise the country’s lacklustre taming of its previous phase of economic decline.

Japan’s plunge into recession came despite a modest 0.3 per cent rise in domestic consumer spending, which accounts for just over 55 per cent of Japan’s GDP. Corporate capital spending was also on the rise, up 1.7 per cent.

Deeper and down

Several other areas are already in recession, including Hong Kong, which confirmed last week that it had experienced two quarters of shrinking economic output

— The United States is widely forecast to be in recession after GDP fell by 0.3 per cent in the third quarter of the year. It will not become official until GDP figures for the final three months of the year are published early next year

— The overall economy of the eurozone, the 15 nations that use the euro, has fallen into recession for the first time since it was created in 1999. Several member countries, including Germany, Italy and the Irish Republic, have confirmed that they are in recession

— France and Spain are not yet in recession, but Spain is likely to be in one at the end of the year, France may stave off a downturn for a little longer. It recorded a 0.1 per cent rise in GDP between July and October

— A recession in Britain is expected to be formally confirmed next January after GDP fell by 0.5 per cent in the third quarter. The CBI said yesterday that it expected output to shrink by a further 0.8 per cent in the final quarter

— Australia’s figures show that the economy was growing in the second quarter, albeit at a slower pace than expected. Economists forecast a further slowdown

— New Zealand’s economy has suffered two quarters of shrinking output between January and June, putting it in recession for the first time in a decade

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