By Yuzo Saeki
TOKYO (Reuters) - Japan sank deeper into recession with its worst quarterly contraction in 35 years, data showed on Monday, its reliance on exports and soft domestic demand dragging down the world's second-largest economy.
The grim Japanese figures, coupled with disappointment over the lack of coordinated action from the G7 and worries about bank rescue plans pushed European shares down by 1 percent in early trade.
In Rome, G7 financial leaders, fearing a 1930s-style resurgence in protectionism, pledged at the weekend to do all they could to fight recession, but major world economies still faced the biggest downturn in decades.
India said government spending may have to rise sharply later this year to shield the economy from the global credit crunch. The announcement in an interim budget worried investors and credit rating agency Standard and Poors said it planned to review the Asian giant's domestic debt rating.
In Britain, falling demand worldwide forced German car maker BMW to announce it was shedding 850 jobs and cutting back production of the Mini at its factory near Oxford in central England.
With U.S. and Japanese interest rates already close to zero, G7 leaders had to look beyond conventional economic tools once they cannot cut rates any further, with a possible return to Japan's experiment with quantitative easing earlier this decade.
European Central Bank President Jean-Claude Trichet foreshadowed "non-standard measures" to tackle the crisis, but said the ECB had not drawn any conclusions after discussions with other central banks.
Trichet gave no concrete plans, but it was hoped he would provide more clues with an address at 1445 GMT (9:45 a.m. EST) on Monday.
UNCONVENTIONAL TOOLS
The Bank of England and the ECB are also heading toward near-zero rates, leaving policy makers searching for alternatives to tools such as rate cuts and stimulus packages.
So-called quantitative easing, in which banks buy assets to raise money supply and boost demand, is now being considered by most of the world's major central banks.
Japan applied the measure with mixed results earlier this decade during its previous battle with deflation, a damaging spiral of falling prices in which consumers defer spending.
The U.S. Federal Reserve has begun what it calls "credit easing" and the Bank of England could follow within a month. However, other ECB policy makers have said measures already put in place were starting to take effect.
The ECB held interest rates at 2 percent this month, but figures last week showing the euro zone economy had shrunk 1.5 percent in the 2008 fourth quarter meant a cut to a record low of 1.5 percent was likely next month.
Even though Japan has been relatively insulated from the collapse of the U.S. credit and housing markets that precipitated the global crisis, Economics Minister Kaoru Yosano said his country faced its worst economic crisis since World War Two.
JAPAN'S WOES
With demand for its cars and electronics waning, an unprecedented slump in exports saw Japan's economy shrink by 3.3 percent, marking three straight quarters of contraction and its worst result since the first oil crisis in 1974.
Adding to the Japanese government's woes, finance minister Shoichi Nakagawa faced calls for his resignation on Monday after denying he was drunk at a G7 news conference. He said he had taken too much cough medicine.
Japan has suffered a sharper contraction than other major economies because of its heavy dependence on exports combined with persistently soft domestic consumption.
"The data showed a severe picture of the Japanese economy and highlighted the weakness in exports," said Takeshi Minami, chief economist at Norinchukin Research Institute.
Yosano said his government must pursue all options to keep the economy afloat, but warned about large-scale spending, saying Japan could not become "addicted to painkillers."
Japanese investors had largely factored in a big fall in GDP, limiting losses after the data was released.
The Nikkei share average fell 0.4 percent, with rises in perceived resilient shares such as drugmaker Daiichi Sankyo offsetting falls in exporters like Canon Inc.
The yen rose against other major currencies despite the bad GDP data after the G7 financial chiefs made no specific mention of the strength of the Japanese currency.
The annualized rate in the fourth quarter of 2008 came in at 12.7 percent, three times the size of the fall in U.S. GDP. There was little sign of an imminent bounce back, with exporters laying off workers and idling plants.
"Many people expected an annualized fall of at least 10 percent, so the actual figure was not that big a surprise," said Shinko Securities technical analyst Yutaka Miura.
"But this did reconfirm that the economy is truly in bad shape, so investors are also reluctant to buy."
In the United States, President Barack Obama will sign on Tuesday a $787 billion economic stimulus package of tax cuts and spending which it is hoped will save or create 3.5 million jobs, although aides warned not to expect immediate results.
Administration officials said Obama would form a task force to oversee the restructuring of the ailing U.S. auto industry.
General Motors Corp and Chrysler LLC are due to submit new turnaround plans by Tuesday showing they can be made viable again after receiving $13.4 billion in emergency aid from the former Bush administration last year.
(Additional reporting by Sumeet Desai in Rome, Elaine Lees in Tokyo, Kevin Krolicki in Detroit, and Reuters bureaux around the world; Writing by Giles Elgood; Editing by Alison Williams)
