(For more stories on the Japanese economy, click [ID:nECONJP])

TOKYO, Feb 16 (Reuters) - Japan’s economy plunged deeper into recession with its worst quarterly decline since the 1974 oil crisis as the global downturn slashed demand for its exports, and economists warned there was more pain ahead.

The world’s second-largest economy shrank 3.3 percent in the final quarter of 2008, more than other major economies, as its heavy reliance on exports and chronically weak domestic consumption left it badly exposed to the worldwide slump.

Group of Seven policymakers pledged at the weekend to do all they could to combat recession while in Japan there is growing debate about how much the heavily indebted government can do to stimulate the economy. [ID:nLE523133]

Adding to the economy’s woes, the deeply unpopular government faces a revolt in parliament, while its finance minister is under pressure to quit after an embarrassing performance at the G7 meeting in Rome, casting doubt over any near-term action.

“There’s no question that this is the worst recession in the post-war period,” Economics Minister Kaoru Yosano told a news conference.

However, he struck a cautious note on large scale spending, saying the government could not get “addicted to pain killers”.

Even though Japan has avoided much of the initial fallout from the U.S. credit and housing market meltdown, its economy contracted at an annualised rate of 12.7 percent -- three times the fall in the United States, at the epicentre of the global turmoil. [ID:nN29308953]

With Japanese exporters cutting production and laying off staff and many retailers reporting sharp falls in sales, economists saw little hope of a rebound.

Four out of six economists quizzed by Reuters forecast a further slide of around 10 percent in the current January-March quarter with one forecasting an even deeper fall.

“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. “The January-March quarter is likely to show another minus figure (annualised) in double digits or something close to double digits.”

POLITICAL TURMOIL

Pressure is building on the government to roll out a third stimulus package, which Japanese media said could include up to 30 trillion yen ($327 billion) in fiscal spending.

But Prime Minister Taro Aso’s tentative hold on power ahead of an election due later this year, is casting doubt over a swift government response to the deepening recession.

Aso faces an upper house of parliament in the hands of opposition parties, a swelling rebellion in his own party ranks and, on Monday, his finance minister and close ally Shoichi Nakagawa was forced to deny being drunk at a G7 media conference in Rome. [ID:nT229091]

“It is a fact that I didn’t conduct myself clearly, and I feel I must put it straight,” Nakagawa told reporters in Tokyo, blaming his shaky performance on a large amount of cold medicine he had taken.

Analysts said a departure by Nakagawa would further weaken Aso’s ability to act.

The Bank of Japan has responded to mounting economic woes by nudging interest rates down near zero and taking unconventional steps, such as purchases of commercial paper and launching a new funding scheme using corporate debt as collateral.

The central bank meets again this week, with markets seeing little scope for more action on rates.

The prospect of more government borrowing pushed Japanese government bonds down. March 10-year government bond futures 2JGBv1 fell more than one-third of a point. FINEWS [JP/]

The Nikkei share average .N225 dipped 0.4 percent but the yen JPY= rose slightly, after the G7 omitted any reference to the currency's strength in its meeting. FXNEWS [FRX/] [.T]

The yen's 24 percent rise against the currencies of Japan's key trading partners in the quarter has added to the pain for exporters such as Toyota 7203.T and Panasonic 6752.T. [ID:nN13360802] [ID:nT322110]

The October-December quarter contraction was Japan’s second-worst in modern times, lagging only a 3.4 percent decline in 1974, after the first Middle East oil shock.

The slump was worse than expected and also bigger than suffered by other major economies.

Euro zone GDP shrank 1.5 percent in the same quarter while the U.S. economy contracted by just under 1 percent for an annualised rate of 3.8 percent.

(For a comparative graphic, double click:

here)

FACTORIES STALL

A plunge in exports was the main culprit behind the massive Japanese contraction, with external demand shaving 3 percentage points off GDP.

The resulting build-up in inventories of unsold cars, flat-screen TVs and many other goods has forced Japanese manufacturers to halt factory lines, pushing industrial production off a cliff and boding ill for the current quarter.

As big exporters cut jobs and production the pain spread to to their suppliers, sending company bankruptcies sky-rocketing and raising worries that the country’s already fragile consumption could sputter even more. ($1=91.80 Yen) (Additional reporting by Hideyuki Sano, Tetsushi Kajimoto, Masayuki Kitano, Editing by Rodney Joyce and Tomasz Janowski)