Japan's central bank has warned that the country's economy faces three years of deflation as it recovers from its worst slump in decades.
The Bank of Japan painted a slightly more optimistic picture of the outlook for economic growth in a twice-yearly report, but warned that prices would keep falling until at least the year to March 2012.
'Japan's economy has started to pick up, and in the second half of fiscal 2009 it is likely to improve gradually on the back of improvements in overseas economies as well as the effects of economic policy measures,' it said.
But it said the pace of recovery was likely to remain 'moderate' until late 2010 because it would take time for the global economy to rebound.
The world's second-largest economy is set to shrink 3.2% in the current financial year to March 2010 before rebounding by 1.2% next year and 2.1% the following year, the Bank of Japan predicted.
Consumer prices are expected to fall 1.5% in the current financial year, followed by a further decline of 0.8% next year and 0.4% the following year, the BoJ said.
The Bank of Japan said it was a 'critical issue' whether the decline in prices resulted in a deflationary spiral which would depress economic activity. But with the pace of deflation expected to gradually slow, that appears unlikely to happen, it added.
Earlier in the day the central bank announced that it would end some of its emergency measures to fight the financial crisis at the end of the year as Asia's biggest economy emerges from a deep recession.
The BoJ has been tackling the credit crunch with super-low lending rates and other steps to support struggling companies, such as purchases of company debt, which will finish at the end of December.
Japan was stuck in a deflationary spiral for years after its property bubble burst in the early 1990s, hitting corporate earnings and prompting consumers to put off purchases in the hope of further price drops.
