The contraction in the gross domestic product, the measure of all goods and services produced in the country, follows a drop of 0.7% in the previous quarter.

Several Tokyo-based economists surveyed on average had forecast a 0.1% drop in GDP for the October-December period from the prior quarter for an annualised drop of around 0.3%.

The new GDP figures make it more likely the world's second-largest economy will shrink for two fiscal years in a row for the first time since the end of World War II.

Gross national product, which discounts inflation, declined by 1 percent, the Economic Planning Agency announced. The Japanese economy shrank by 0.7% for the 1997-98 fiscal year, which ended March 31, in the first annual drop since 1974.

Last year, Japan began massive public spending to boost the economy. Determined to prevent therecession from dragging on further, Japan's parliament also plans record spending in the budget for the fiscal year beginning April 1. The $682.5 billion budget includes a stimulus package of public works and tax cuts.

The government is also in the midst of a massive bailout of Japan's many troubled banks. The banks were left with massive bad loans leftover from the excessive lending and speculation of the 1980s.

Monetary policy is left unchanged

About an hour after the GDP figures were released, the Bank of Japan announced its policy-setting board voted to leave its monetary policy unchanged. That decision was widely expected, since Bank of Japan officials have said in private lately that they were still assessing the impact of the latest round of easing Feb. 12.The BOJ is steering its target for a key interest rate, the overnight call rate, which banks charge each other for overnight loans to around 0.15% from an average of 0.25%.

Government officials sought to play down any speculation thatFriday's figures would force them into further action. EPA Director-General Taichi Sakaiya said economic steps that are already planned are "sufficient" for now, while Chief Cabinet Spokesman Hiromu Nonaka said: "the Obuchi Cabinet is proceeding with every conceivable policy measure. We're starting to see results here and there."But analysts said they expect pressure to build nonetheless.

"The fact that these figures were so much worse than expected leads me to believe that the government has underestimated the economy's weakness up until now," said Kenneth Landon, senior currency strategist at Deutsche Bank in Tokyo. "I think the figures will put more pressure on (policy makers) to take action."

Officials see signs of recovery

Japan's jobless rate remained at a record-high 4.4% in January for the third month in a row, the Management and Coordination agency reported earlier this month. Bankruptcy debts were still high and a credit crunch was squeezing companies.

In recent weeks, however,various Japanese government officials have made comments about some signs of an economic recovery. Finance Minister Kiichi Miyazawa said Friday the struggling economy "may now have turned the corner." Mr. Miyazawa until recently had shown a more cautious assessment.Also, a research company announced that corporate bankruptcies plunged 40% in February compared to a year earlier, dropping below 1,000 for the first time in six years. Last month, an advisory body to the prime minister, the Economic Strategy Council, predicted that Japan should regain a 2% annual growth rate by the end of fiscal 2001.