Japan's government kept its view of the economy unchanged in December, snapping a four-month-long run of downgrades that was the longest such sequence since the 2008-09 financial crisis, but warned the overall economic environment remained sluggish.
In its monthly assessment of the economy, it said that while weakness would remain for now, a recovery from Japan's fourth recession since 2000 was expected as domestic demand picks up on the back of reconstruction spending following last year's earthquake and an improvement in the global economy.
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The report came a day after the Bank of Japan delivered its third shot of monetary stimulus in four months, as it faces growing pressure from incoming Prime Minister Shinzo Abe for bolder action to beat deflation.
The government's cautious assessment may pile even more pressure on the central bank for further policy easing measures. The bank signaled setting a higher inflation target at its next meeting in January, when a new government will be in place.
"There are some bright spots here and there, but overall, the economy remains weak and we can't be optimistic," a Cabinet Office official in charge of compiling the report said in a cautious assessment of the world's third-largest economy.
"Companies, especially manufacturers, continue to operate in a tough environment and their profits are sluggish, with a drop in exports weighing on production and business sentiment."
The report warned that lingering uncertainty over the U.S. "fiscal cliff" budget crisis, the euro zone debt problems and a slowdown in China remained major downside risk factors.
Policymakers were also concerned that a weak manufacturing sector would hurt the broader economy as companies cut wages and delay investment, keeping the pressure on for easing steps from the Bank of Japan to compensate.
A correction to the downtrend in car and electric equipment manufacturing was behind an improvement in the assessment of industrial output. A downtrend in private consumption slowed as well and the view was revised up for the first time in seven months.
"It's not like we're seeing a huge improvement in manufacturing, but the downtrend in production of cars and electric equipment used in smartphones and tablets has paced down slightly," a Cabinet Office official said.
These factors were offset by a continuing slump in exports in the face of the global slowdown and further deterioration in capital spending plans on weak demand in overseas markets, adding to evidence that any rebound from recession early next year could be weak.
The government also cut its view of corporate profits, saying that they are flattening further, mainly among manufacturers. It did not change its assessment of bankruptcies and the employment situation.
Japan's economy outperformed most of its Group of Seven peers at the start of the year on robust spending by consumers and reconstruction following the devastating earthquake and tsunami in March 2011.
But the economy contracted for a second straight quarter in July-September, meeting the rule-of-thumb definition of a recession, and analysts expect another contraction in the final three months of this year.
(Reporting by Antoni Slodkowski; Editing by Alex Richardson)