It was the fourth quarter in a row that the Japanese economy has shrunk in the most severe recession to strike Japan since World War II.

Economic Planning Agency chief Taichi Sakaiya admitted that, at the current rate, even the government's prediction of a 1.8% decline in the fiscal year to March might turn out to be "difficult" to meet.

But he said the economy had bottomed out and the effects of the government's rescue package would begin to come through.

"The pace of decline is slowing," he said.

Consumers and firms cut back

The figures showed that Japanese companies were cutting back sharply on new investment in plant and equipment. Capital spending fell by 4.6% from the last quarter, while personal consumption also dropped by 0.3%.

In a sign of the pressure on companies, one of Japan's largest construction firms, JCB Corp, filed for bankruptcy on Monday with debts of $3.3bn.

It is the second big construction company to go under in the past 18 months.

"The consensus here is that there are tremendous levels of excess capacity in the construction industry and that there are quite a number of companies whose existence, particularly in the current form, really is questionable," said Alicia Ogawa, head of research at Salomon Smith Barney.

The only factors sustaining the economy have been exports, which added 0.9% to growth, and public sector investment, which grew by 3.6%.

Government rescue not working

In October the government announced a ¥24 trillion ($200bn) economic stimulus package to try to reverse the economic decline.

And it is putting even more money into rescuing the troubled banking sector which has an estimated $680bn in bad debts.

Prime Minister Keizo Obuchi has pledged to get the Japanese economy out of recession by the middle of next year.

But economists were sceptical that the economy would respond to the latest stimulus package.

"The government is shrugging this off as ancient history, but there are problems still plaguing this economy. The prospect for recovery is quite remote," said Andrew Shipley of Shroders Japan.