Japan is the world's second biggest economy

Government data showed gross domestic product (GDP) grew 1.7% in the previous 12 months, and 0.4% in April to June.

This was well below expectations, and has been put down to a deceleration in the fast-paced expansion in domestic demand seen up to the previous quarter.

The Nikkei stock index fell by almost 2.5% on the news, coming as it did on the back of US economic worries.

And the yen fell more than 1% against the dollar, and hit a three-month low against the euro.

Meanwhile, growth in the preceding January to March quarter was upgraded to 1.6%, from 1.5%, or an annualized rate of 6.6%, up from 6.1%.

Despite the sluggish figures economists and government officials said a recovery was still intact, with Japan experiencing a fifth straight quarter of growth.

A decline in automobile purchasing largely accounted for the drop in domestic demand.

'Exports strong'

Corporate spending was flat, which baffled many observers who had seen it as a main growth provider in the quarter.

"The GDP figure was quite bad compared with the overall consensus but I think the balance of the economy is looking fine," said Torikoshi Tatsuya, an economist at Daiwa Institute of Research.

"I think exports are quite positive so the economy is likely to remain steady with external demand-led growth until the end of this year."

Earlier this week, the International Monetary Fund (IMF) raised its growth outlook for the Japanese economy.

The Washington-based lender forecast that Japan's gross domestic product would rise to 4.5% in 2004, topping a previous estimate of 3.4%.

The world's second biggest economy has been experiencing price deflation, and has held interest rates at close to zero until those pressures ease.