This article is more than 11 years old

This article is more than 11 years old

Japan could be heading for its worst recession since the second world war after figures released today showed industrial output fell almost 10% last month and unemployment rose at its fastest pace for more than 40 years.

Production fell 9.6% in December, the trade ministry said, surpassing November's huge drop by more than one percentage point.

The global recession has sent shock waves through Japan's economy, forcing once-powerful exporters to rein in production, slash jobs and close factories in response to plummeting demand for cars and consumer electronics.

NEC, the computer chip maker, announced it would make 20,000 workers redundant worldwide as it struggles to cope with falling demand, while carmakers Toyota and Honda said their losses would worsen this year.

Today's figures, however, offered evidence that the malaise had spread to the domestic economy.

Unemployment rose to 4.4% in December, its biggest monthly rise for 42 years, from 3.9% a month earlier. The jobless total has risen over the last year by 390,000 to 2.7 million, as the spectre of deflation and flat consumer spending returned to haunt companies and their employees.

Household spending fell by 4.6% in December, the 10th consecutive monthly fall, while core consumer inflation edged up a mere 0.2%.

"Companies are not only cutting production but also cutting employment, which is deeply unsettling for households," Martin Schulz, senior economist at the Fujitsu Research Institute, told theguardian.com.

"We are now looking at a domestically driven recession. The domestic economy is at risk of falling apart, and if that happens we are looking at a really deep, long recession. Even if that doesn't happen, things are already bad enough."

With Japan's non-regular employees, who now comprise a third of the workforce, at increasing risk of being laid off, families are refusing to spend, and analysts say the government's much-derided handout of ¥12,000 (£94) for every individual is unlikely to have any impact.

Predictions of further falls in production in the coming months are making prime minister Taro Aso's boast that Japan will be the first to emerge from the recession look increasingly hollow.

The economics minister, Kaoru Yosano, admitted the economy was "in a very grave situation".

"Japan is being hit by a wave of weakening global demand," he said.

The plight of Japan's exporters was underlined yesterday when Toshiba forecast record annual losses. Toyota, meanwhile, could be heading for an operating loss - its first for more than 70 years - of about ¥400bn for the year to the end of March, reports said today, while Sony is bracing itself for record losses this year.

Although factory production is at its lowest level for 20 years, cuts in output have barely dented bloated inventories, prompting speculation there could be more reductions.

Exporters' desperate attempts to climb out of the crisis are being hampered by the strength of the yen, which gained 23% against the dollar and 29% against the euro last year.

Economists predict that fourth-quarter GDP figures, due out next month, would show the world's second biggest economy shrinking at a double-digit annual rate.

In addition, the International Monetary Fund warned that Japan's GDP would contract by 2.6% this year, the gloomiest prediction of all the G7 countries except Britain. If the IMF forecast is correct, it would be the worst contraction since the end of the second world war.

"As output adjustments continue, weakness in the overall economy will persist from January to March, and the degree of worsening depends on how exports turn out," said Tatsushi Shikano, senior economist at Mitsubishi UFJ Securities.

"It is already a consensus view that core consumer inflation will turn negative soon, but we must watch if a worsening of the economy pushes Japan into a deflationary spiral, even though the Bank of Japan sees no signs of that happening right now."

The gloomy data stopped in its tracks a three-day rally by the Nikkei, sending the benchmark index tumbling 3.1% in Tokyo.

Nintendo shares sank 12% after the video game maker cuts its earnings and sales forecasts. The company, which had enjoyed huge sales of its DS and Wii game consoles, said yesterday that annual operating profit would fall by 16%. Honda, Toyota, Sony and Toshiba were also down.

The Nikkei has lost more than 10% this year after shedding more than 40% last year.

The Bank of Japan is buying up corporate debt and recently brought interest rates down to just above zero, while the government this week passed a $53bn stimulus package and launched a $16.7bn fund to buy shares in struggling firms.

But Schulz said Japan's financial authorities were running out of options to save the economy from a deeply damaging recession.

"The government has few tools left to deal with this. Japan managed to shield failing companies during the last recession – the so-called zombie firms – but you cannot protect companies from a breakdown in demand in the domestic economy."