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Japan's economy shrinks in post-disaster stall

File photo of workers checking paints and bodies of Toyota Motor's best selling car "Corolla" at a plant of the company's subsidiary Central Motor at Ohira village in Miyagi prefecture, northern Japan. Demand for Japanese cars has plunged in China, the world's biggest vehicle market, amid a consumer boycott that followed a territorial dispute over islands in the East China Sea

Japan's economy shrank in the July-September quarter, data showed Monday, raising fears it could slip into recession owing to Europe's debt woes, a strong yen and a painful diplomatic row with China.

The world's third-largest economy contracted 0.9 percent over the three months, equivalent to an annualised 3.5 percent, which Prime Minister Yoshihiko Noda described as "severe".

The fall is yet more bad news for an economy that was already showing signs of strain, with tumbling factory output, weakening household spending and the worst September trade figures in three decades.

And commentators warned the future is bleak, with a litany of worries including the Chinese consumer boycott of Japanese goods caused by a diplomatic row, a strong yen and the expiry of incentives for car buyers.

Noda -- under pressure to call a general election -- told parliament on Monday he would work "with a sense of crisis" to address the country's financial woes, as he repeated promises of further help to inject some life in the economy.

"I have also been instructing ministers concerned to draw up an economic package possibly this month," Noda said, as he pointed to the first $5.0 billion tranche of previously-announced stimulus.

The package came on top of measures taken in the wake of last year's quake-tsunami, when Tokyo tried to spur growth by offering incentives for fuel-efficient vehicle purchases and measures to rebuild the northeastern region hit by the disaster.

While the latest figures actually beat market expectations of a 3.9 percent annualised contraction it was the sharpest since last year's disasters paralysed growth.

The trade picture has become increasingly bleak as exports to China, especially in the car market, suffer because of the boycott that followed Japan's nationalisation in September of an East China Sea island chain claimed by both Tokyo and Beijing.

"Deterioration in external demand will likely continue through the October-December period as the negative impact from China is expected to remain," RBS Securities chief Japan economist Junko Nishioka told Dow Jones Newswires.

Nishioka added that the economy was unlikely to show growth again "until the April-June period at the earliest", as the global slowdown and weakness in Europe, a key export markets for Japanese products, strangle growth.

Another three months of shrinkage in October-December would mean Japan has slipped back into a technical recession, which is defined as two successive quarters of contraction.

Last month, the Bank of Japan unveiled $138 billion in fresh monetary easing after central banks in the United States and debt-hit Europe also announced policy easing measures to stoke growth.

The central bank, which also said it would provide new loans to banks, had been under pressure from politicians calling for urgent action.

But the BoJ's stimulus came with a warning that the economy was on track to expand just 1.5 percent in the year to March, well off an earlier 2.2 percent estimate.

The strong yen is a particularly acute problem for major export brands such as automakers, with Honda and Nissan recently warning their full-year profits would shrink because of the surging currency and the China spat.