Japan will overtake US economic growth this year as it emerges from its decade-long slump, the International Monetary Fund (IMF) predicts.
Japan's economic recovery relies on an increase in consumer spending
Rising private investment, strong company profits and a pick up in exports should push growth to 2.3%.
In its latest World Economic Outlook, the IMF cut its projection for US growth to 2.2%, reflecting increased problems in the housing market.
Japan should then slip back behind the US in 2008 with growth easing to 1.9%.
Japan's recovery stalled briefly in the middle of 2006, reflecting a drop in consumption, but the economy rebounded strongly in the last three months of the year, said the report.
"Near-term prospects depend crucially on whether the rebound in consumer spending in the fourth-quarter is sustained," the IMF said.
It said this spending should be encouraged by the hiring of more full-time workers by Japanese companies.
A recovery in domestic Japanese consumption is expected to largely offset some cooling of exports in view of the anticipated moderation in global growth, expected to ease to 4.9% in 2007 and 2008 - half a percentage point less than 2006.
But the IMF urged the Bank of Japan (BoJ) to keep interest rates low to beat lingering deflationary pressures and renewed its call for greater policy transparency from central bank.
"The transition to a more neutral monetary stance could be supported by greater clarity regarding the Bank of Japan's medium-term inflationary goals, which would facilitate a smooth adjustment of private sector interest rate expectations," the report observed.
The BoJ kept interest rates on hold at 0.5% this week for the second meeting in a row following a quarter point hike in February.