Japan's economy shrinks 2.3 per cent

Japan's economy shrank 2.3 per cent in the fourth quarter of 2011 as manufacturers were battered by the strong yen, weak export demand and flooding in Thailand.

A drop in government spending during the quarter, due largely to political bickering delaying parliamentary approval for a Y12 trillion ($A145 billion) extra budget for tsunami reconstruction, also contributed to the year-on-year decline reported on Monday.

The world's third biggest economy should get a boost once that rebuilding money kicks in, but the outlook for the country's vital exporters remains unclear, said Masayuki Kichikawa, chief Japan economist at Bank of America Merrill Lynch.

"This should be viewed as a temporary setback," Kichikawa said. "To what extent will the European crisis continue to affect overseas demand. That is the big question."

Japan's major manufacturers were hit badly during the fourth quarter by a drop in export demand and flooding in Thailand, a regional factory and supply base, which disrupted production.

The problems arose just as many exporters appeared to have recovered from the March 11 earthquake and tsunami, which interrupted their manufacturing at home.

The drop was worse than expected. Economists polled by Kyodo News agency projected a 1.4 per cent decline.

Compared with the previous quarter, October-December gross domestic product fell 0.6 per cent, the cabinet office said.

That comes after 1.7 per cent increase in the July-September quarter, reflecting some recovery after the tsunami disaster.

Domestic private consumption, which accounts for more than half the economy, edged up 0.3 per cent during the quarter, the data showed.

"The growth rate will turn positive and stay positive this year because reconstruction demand will continue to push up GDP," said Kichikawa. "But the pace of growth will depend on whether the decline in exports will stabilise."

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