TOKYO (AFX) - The Japanese government issued data today showing the economy shrank in October-December, the third consecutive quarter of contraction, meaning the world's second-largest economy has slid back into recession

But Japanese stocks continued to rise, while the yen weakened only slightly against the dollar and euro, as economists said the economy is likely to rebound soon, as accelerated growth in the US boosts Japanese exports while the improving domestic labor market at last begins to fuel a pickup in domestic demand

The Japanese economy shrank by a real 0.1 pct in the October-December quarter, or at an annualized rate of 0.5 pct, the Cabinet Office reported, worse than market expectations

Real growth was forecast at 0.1 pct, or an annualized rate of 0.5 pct, according to the average estimate of 22 research houses polled by the Nihon Keizai Shimbun. The forecasts ranged from a decline of 0.1 pct to growth of 0.5 pct, or on an annualized basis, a contraction of 0.4 pct to growth of 2.2 pct. The Cabinet Office also revised down July-September real GDP to show a contraction of 0.3 pct quarter-on-quarter, from the previous estimate of 0.1 pct growth. The Japanese economy also shrank by 0.2 pct in the March-June quarter, as surging global oil prices and action taken by Chinese authorities to rein in runaway growth combined to trigger a sharp slowdown in Japanese economic growth

The Japanese economy had grown at annualized rates exceeding 6 pct during the final quarter of 2003 and first quarter of 2004, raising hopes that it was at last soundly recovering from more than a decade of stagnation. The three-quarter decline is the worst since the economy contracted for four consecutive quarters from April-June 2001 to January-March 2002, when it was hit by the burst of the information technology bubble

Still for the whole of 2004, the economy still expanded 2.6 pct, the highest growth since 1996 when it grew by 3.4 pct

Economists said the depressed spending in the last quarter of 2004 was due to a series of natural disasters, such as a devastating earthquake and a record number of typhoons, along with the relatively warm start to the winter

A quake measuring 6.8 on the Richter scale jolted the northern province of Niigata on October 23, leaving 40 people dead and 2,857 injured while disrupting production at several major companies

"Decline in household consumption is apparently affected by one-time factors such as (extraordinarily many) typhoons and (a big) earthquake last year," said Takenori Shimada, an economist at Dai-ichi Life Research Institute

"I would say that in the January-March quarter household spending will recover, thus contributing to economic recovery," Shimada added

Household spending fell 0.3 pct the past quarter, following a 0.2 pct decline the previous quarter

Shimada and many other economists expect household spending to pick up because of other data showing worker compensation rose 0.3 pct last quarter, possible marketing an end to a 13-year slide in average wages

Shimada said he expected a recovery in household spending in the January-March quarter, together with the likely recovery in overseas economies from this spring, to support a rebound in Japan's growth possibly from autumn

"Despite the fact that inventory adjustment is continuing in the IT-related sector in particular, corporate capital investment activities are still robust, which is another sign of Japan's steady path toward recovery," Shimada said

Private non-residential investment, nearly equivalent to corporate capital investment spending, rose 0.7 pct last quarter, or an annualized rate of 2.9 pct

Today's GDP data also showed a further lessening of deflation in Japan, the major cause of its decade-long economic funk

The GDP deflator for the October-December quarter eased to minus 0.3 pct year on year, from minus 1.3 pct the previous quarter

"We can say deflation is easing," a Cabinet Office official said

Market reaction to the GDP data was limited

Japanese stock prices were up slightly by 27.64 points or 0.24 percent at 11,674.13 in early trade after opening lower Wednesday while there was brief yen selling in the currency market

The dollar rose to a high of 104.66 yen in early Tokyo trade Wednesday from 104.42 yen in New York late Tuesday

"The weaker-than-expected GDP data prompted yen selling, but selling was modest as investors were cautious ahead of Greenspan's testimony," said Shigetake Nakayama, a currency dealer at UFJ Bank