By Tetsushi Kajimoto and Hideyuki Sano
TOKYO (Reuters) - Japan's economy shrank at a record pace in the first quarter and any lasting recovery will hinge on how soon the global economy can be healed and demand in the West can grow, economists said.
Economists say there are signs the world's worst recession in six decades might be easing, but with companies slashing jobs and costs, any recovery remains elusive and the consumer and business confidence needed to drive demand is patchy.
Japan, the world's second-largest economy, contracted 4.0 percent in January-March as capital spending sank at the fastest pace on record and private consumption suffered its biggest decline since 1997.
"The export plunge is spreading to domestic demand," said economist Hiroshi Shiraishi at BNP Paribas. "As such, the Japanese economy may return to growth temporarily but it could suffer a contraction again afterwards."
World Bank President Robert Zoellick said in Finland after a meeting of Nordic and Baltic central bankers the global situation was still getting worse, but "we are likely to see the rate of decline lessen."
Economists say the U.S. economy may not emerge from its slump until the housing market stabilises, and data from the Mortgage Bankers Association on Wednesday showed demand for mortgages to buy a home in the United States fell.
Applications for refinancing loans rose, as homeowners tried to take advantage of lower interest rates.
"Purchase transactions in general have been at a very measured pace due to the uncertainty associated with the banking sector and unemployment," David Adamo, CEO of Luxury Mortgage, in Stamford, Connecticut.
The market is edging closer to a bottom, a Reuters poll found, but the timing of a turnaround is highly uncertain.
Many economists expect a further 10 percent fall in U.S. home prices, which could dampen optimism over the bank sector.
The collapse of the housing sector in Spain and unemployment reaching 17 percent, the highest rate in the European Union, led to the economy, the fourth largest in the euro zone, contracting even more than expected in the first quarter.
The European Commission expects Spain to be the last European Union member to exit the recession, probably in 2011.
CHINA, EU MEET
The European Union and China, one of the few growing economies, were meeting in Prague on Wednesday to try to work together to tackle the global downturn.
"Under the storm of the financial crisis, we all understand better that our cooperation means a lot to us and to the world," said Beijing's ambassador to the EU, Song Zhe.
Officials in China have been increasingly confident that an 8 percent target for economic growth this year can be achieved with the help of Beijing's stimulus package and said extra measures would be taken to maintain the momentum of a recovery.
Economists have said falling inventories of oil and metals and a reduced number of unsold homes indicate the recession may be easing, but the question is whether this reflects a return of real demand or a running down of stocks.
Oil firmed above $60 a barrel on Wednesday to touch a six-month high after data showed U.S. crude stocks fell a much larger than expected 4.5 million barrel in the week to May 15.
But such confidence in the outlook for the months ahead, also seen in German data on Tuesday, is nowhere near universal.
CONFIDENCE
Australian consumer sentiment fell in May, reversing some of last month's surge, as many consumers were wary of a debt-fuelled budget unveiled by the government.
"The fall provides a reminder that confidence can be fragile especially in an environment of rising unemployment," said Su-Lin Ong, senior economist at RBC Capital.
Showing the weakness in the real economy, a recovery in cellphone demand will not happen until well into 2010, researcher Gartner said on Wednesday, while Reuters data showed the industry could suffer its worst quarter ever in April-June.
But there is optimism among investors that sharp contractions in the U.S. and euro zone economies in the past quarter have marked the low point in the recession and world stocks rose for the fourth session in a row on Wednesday.
Japan's heavy reliance on export industries for growth has seen its economy suffer more than those of its peers, which took a much bigger hit from the global financial meltdown that began in the U.S. mortgage market.
The U.S. economy sank 1.6 percent in the first quarter, while the euro zone economy contracted 2.5 percent.
Some economists forecast tepid growth through the year, saying Prime Minster Taro Aso's $160 billion (103 billion pounds) stimulus plan, the largest in Japan's history, would boost consumption, which accounts for about 55 percent of GDP.
Although the market rally appears robust, some investors are looking for real improvement in the world economy.
"Expectations of economic news have adjusted and it may now take continued positive news to keep the market moving higher," Goldman Sachs said in a note.