TOKYO - JAPANESE industrial production dropped sharply in October and manufacturers warned of even more dramatic falls in coming months, prompting warnings that Japan's recession will be even deeper and longer than previously thought.

The bleak industrial data, combined with sliding household spending and falling retail sales, will reinforce the Bank of Japan's focus on downside risks for the world's second-largest economy, but economists remain divided on whether it will cut its already low rates even further, even as the risk of deflation grows.

Japan is now firmly caught up in the financial crisis, with its big exporters such as Toyota and other car makers facing tumbling orders from key customers in the United States, Europe - and increasingly Asia as well.

'Production is falling much faster than we had expected. Companies are adjusting their production very quickly. The auto makers are the worst hit, but their turmoil is starting to spill over into other sectors, such as steel makers,' Mr Tsunoda said.

Industrial output fell 3.1 per cent in the month of October, more than a median market forecast for a 2.5 per cent drop, and the outlook was for a record fall of 6.4 per cent in November - pointing towards an 8.6 per cent contraction for the fourth quarter.

Industrial output has already been falling for three quarters of this year and, with household spending also in decline, economists warned of a longer and deeper recession ahead.

'The figures reconfirm that the conditions are worsening very badly,' said Mr Yoshikiyo Shimamine, chief economist at Dai-Ichi Life Research Institute, and he warned US data and problems elsewhere meant there would be no quick turnaround.

'It is now the Christmas shopping season in America, and sales of popular items like toys, clothing, high-tech gadgets and digital appliances will likely be really slow.

'Chinese firms may be hit by slow sales of toys and clothing, but sluggish sales of high-tech items will impact companies in Japan and Taiwan.'

Deflation risk
Japanese core annual inflation slowed in October for a second straight month, underscoring a view that falling energy costs may heighten the risk of the nation returning to deflation later next year.

The core consumer price index, which excludes volatile fresh fruit, vegetable and seafood prices but includes oil products that are diving in price, rose 1.9 per cent in October from a year earlier, matching the market forecast and slipping from a 2.3 per cent increase in September. Partial figures for November, covering the capital city, pointed to further falls in inflation.

'The pace of rises in consumer prices will keep slowing towards the July-September quarter next year and we expect core consumer prices to start falling after July-September next year,' said Mr Kyohei Morita, chief economist at Barclays Capital.

The OECD has singled out Japan as facing the biggest threat of deflation among industrialised nations next year, warning on Tuesday that the global financial crisis could further damage the economy.

Analysts are split over whether the threat of deflation will prompt the Bank of Japan to cut rates again in the future after it trimmed them to 0.3 per cent last month. But other analysts see limited scope for a BOJ rate cut and derivative markets are not pricing in a serious chance of a rate cut in coming months after Friday's data.

Bank of Japan Governor Masaaki Shirakawa said this month he was awake of the risk of deflation. But the central bank does not forecasts a return to it, which afflicted the nation for about a decade from the 1990s.

Japan slipped into recession in the third quarter for the first time in seven years as exports crumbled, joining the euro zone in meeting the commonly used definition of recession, which is for two straight quarters of contraction. -- REUTERS