The government on Wednesday downgraded its assessment of Japan's economy for the first time in 10 months, saying it is recovering moderately but "appears to be pausing in part" on weak domestic demand, a worrying sign before new inflation relief steps are rolled out.

Among key components, the Cabinet Office cut its view on capital spending, the first in nearly two years, noting in its monthly report that the recent pick-up is "pausing" partly due to slowing global growth, particularly in China.

Prime Minister Fumio Kishida (3rd from front L) attends a ministerial meeting on the government's monthly economic report at his office in Tokyo on Nov. 22, 2023. (Kyodo)

The latest assessment came after Japan's economy marked its first contraction in three quarters in July-September, with gross domestic product falling at an annual real rate of 2.1 percent, as capital spending and private consumption, both key gauges of domestic demand, fell and export growth slowed.

Until October, the government described the economy as "recovering at a moderate pace" for six consecutive months.

Diet deliberations began this week on a 13.20 trillion yen ($89 billion) extra budget for the current fiscal year to next March to fund an economic package aimed at easing the pain of rising prices on households and navigating the economy through the cost-of-living crisis to a longer-term growth path.

While corporate earnings have been robust and Japanese firms have bullish investment plans for fiscal 2023, this has yet to translate into rapid growth in capital spending. Previously, the view on spending by firms was cut in December 2021.

The Cabinet Office retained its assessments on other components in November.

Private consumption is "picking up," supported by a continued recovery in demand for services, even as rising prices of everyday goods weigh on demand and consumers have become more frugal.

Both industrial production and exports show signs of "picking up," the report said.

The government continued to warn of downside risks to the economy from the impacts of aggressive interest rate hikes overseas and a slowdown in the Chinese economy.

"Full attention should be given to price increases, the situation in the Middle East and fluctuations in the financial and capital markets," the office said.

A persistently weak yen is expected to keep raising energy import costs to the detriment of resource-scarce Japan, which will then be passed on to consumers.

Under the recently compiled inflation-relief measures, the government will extend existing subsidies to lower fuel costs for consumers until next spring. Japan's inflation has been easing from its peak as the boost from higher energy and raw material costs has lost steam.

The government retained its assessment of the global economy, saying that it is "picking up despite weakness in some regions."

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