TOKYO - JAPAN factory output slumped and consumers tightened their purse strings in October as recession took a tighter hold on Asia's largest economy, official figures showed on Friday.

Japan's industrial production tumbled 3.1 per cent from the previous month as manufacturers slowed their factory lines to cope with the worst financial crisis since the Great Depression, the government said.

The drop was bigger than market forecasts of a 2.6 per cent decline.

Manufacturers said they expected output to tumble 6.4 per cent in November and a further 2.9 per cent in December.

Consumer spending dropped 3.8 per cent in October from a year earlier as Japanese households grew more reluctant to splurge following months of grim news on the economy and the plunging stock market.

The figures painted a gloomy picture of prospects for the economy, said Yasuo Yamamoto, senior economist at Mizuho Research Institute.

'Production and exports will see a severe adjustment through the rest of the year and in the quarter to March,' he said.

Japanese exports fell at the fastest pace in almost seven years in October, tumbling 7.7 per cent from a year earlier, as once-buoyant shipments to the rest of Asia started to drop, earlier figures showed.

One bright spot in an otherwise dismal batch of reports on the world's second-largest economy was an unexpected reduction in the unemployment rate to 3.7 per cent in October from 4.0 per cent in September.

But there were only 80 job opportunities for every 100 job seekers, suggesting that it is becoming more challenging to find work.

'Domestic demand remains weak, and a drop in unemployment seems to be temporary,' said Mr Yamamoto.

Japanese companies have been slashing jobs in recent weeks to cope with the recession, although Japan's ageing population is helping to keep the headline unemployment rate down as post-war baby boomers retire.

Core inflation slowed to 1.9 per cent in October as oil prices fell and a stronger yen reduced the cost of imports, adding to concerns that Japan may slip back into deflation.

Last month, Japan's central bank cut interest rates for the first time in seven years to try to ward off a deep recession, lowering its key lending rate by 20 basis points to just 0.3 per cent.

Some analysts expect a return to virtually free credit in Japan.

'I think the BoJ will be forced to cut rates by the end of this year,' Mr Yamamoto said.

The Organisation for Economic Cooperation and Development predicted this week that Japan would sink back into deflation in the second half of next year, requiring its interest rates to be kept very low, possibly beyond 2010.

Markets showed little reaction to the data, which Sumitomo Trust Bank forex strategist Saburo Matsumoto described as 'pretty bad'.

The dollar was slightly weaker at 95.52 yen in Tokyo morning trade, while Japanese share prices edged higher.

'While the impact on the yen was limited, we are unable to remain optimistic about the yen in the coming month,' said Mr Matsumoto. -- AFP