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By Leika Kihara
TOKYO, Nov 17 (Reuters) - Japan slid into its first recession in seven years in the third quarter as exports crumbled, and some analysts said an escalation in the global financial crisis may have put the economy on course for its longest ever contraction.
The 0.1 percent contraction in July-September gross domestic product barely captured the impact of the financial fire-storm that began in mid-September, wrecking Wall Street banks, triggering a stock market crash in Tokyo and a yen rally that may hit exporters even harder.
The euro zone is also in recession, using the common definition of two consecutive quarters of contraction, and the U.S. economy is expected to follow, having shrunk in the third quarter.
Recession in industrialised economies underscores the challenge facing world leaders who backed a plan on Saturday to combat the global crisis by stimulating growth, although they failed to impress markets.
Some economists said Japan, the world's second-largest economy, could be headed for a record four quarters of shrinking output while Economy Minister Kaoru Yosano warned of increasingly tough times ahead.
"The downtrend in the economy will continue for the time being as global growth slows," Yosano told a news conference.
"We need to bear in mind that economic conditions could worsen further as the U.S. and European financial crisis deepens, worries of economic downturn heighten and stock and foreign exchange markets make big swings."
Tokyo's Nikkei share average has fallen by a quarter since the start of October, potentially denting consumption, and the yen spiked to a 13-year high against the dollar last month, hitting exporters.
External demand detracted 0.2 percent from GDP in the third quarter as imports grew faster than exports, and, while private consumption rose 0.3 percent, Yosano said that was due to one-off factors.
The third quarter GDP figure translated into an annualised contraction of 0.4 percent, compared with a consensus market forecast for a 0.3 percent expansion, government data showed.
Japan's second-quarter economic contraction was revised in Monday's data release to a steeper 0.9 percent slide, the biggest drop in seven years.
A YEAR OF PAIN?
Bank of Japan Deputy Governor Kiyohiko Nishimura warned that the market turmoil may not be over.
"Due to strong awareness of counterparty risks in the dollar markets, the function of these markets is declining and Japan's financial market is also becoming unstable," Nishimura said at a seminar on financial markets.
Some economists said GDP could slide for a full year.
"The risk of Japan posting a third or fourth straight quarterly contraction is growing, given the fact that we can no longer rely on exports as overseas economies are slowing down due to the spread of the financial crisis," said Takeshi Minami, chief economist at Norinchukin Research Institute.
For a graphic of the quarterly GDP change, click:
https://customers.reuters.com/d/graphics/JP_GDPR1108.gif
The yen dipped after the data, but a global flight to low-risk currencies meant the fall was shortlived. Japan's Nikkei share average fell 2.5 percent before bargain hunters turned the index around and it closed up 0.7 percent.
In a sign of how the global economic slump was hitting Japanese companies, capital expenditure fell 1.7 percent in July-September.
Corporate spending and exports were the main drivers of Japan's longest economic expansion since World War Two, which appears to have ended after defaults on U.S. mortgages triggered a global credit squeeze last year.
"Japan will probably post a continuous and more notable contraction as a slowdown in global economies is expected to affect exports and the appetite for capital spending, which will then hurt consumer spending," said Taro Saito, a senior economist at NLI Research.
On Friday, the 15-nation euro zone reported its economy shrank 0.2 percent for the second quarter in a row, and most economists say the United States is probably in recession, although official data confirming that will not come until January.
The Bank of Japan joined a global easing drive last month, and cut its key interest rate last month to 0.30 from 0.50 percent.
Economists are divided over whether the central bank will cut even further, with some forecasting a return to Japan's policy of zero interest rates, adopted to lift the country out of a decade of deflation that began in 2000.
The government is planning spending to stimulate growth.
"It's too late for monetary policy to revamp the economy. The economy needs to depend on fiscal policy," said Kyohei Morita, chief economist at Barclays Capital Japan. (Additional reporting by Tetsushi Kajimoto, Yuzo Saeki, Yasuhiko Seki; Writing by Rodney Joyce; Editing by Hugh Lawson)