Japan's top banker has hinted a shift of policy is on the horizon

Industrial output also rebounded during the month, rising 1.2% in August from July, the government said.

The upbeat economic picture came as the Bank of Japan's governor suggested the bank may shift its policy of keeping interest rates close to zero per cent.

Toshihiko Fukui said the policy, which aims to stimulate Japan's deflation-hit economy, could change early next year.

The world's second-biggest economy has been struggling against falling consumer prices, which encourages shoppers to put off spending whilst swelling the real value of companies' debt.

Spending rises

Japan's unemployment rate fell to 4.2% in August, from 4.4% in July, raising hopes that an increase in the workforce could eventually lead to higher consumer spending.

"The unemployment rate crept up last month, but that was because of an increase in people coming into the labour market," said Kaori Yumoto, an economist with Mizuho Research Institute.

"The decline this month reconfirms the improving underlying trend."

Separate government figures showed that spending by households headed by salaried workers rose by 3.2% in August from July.

Overall consumer spending accounts for about 55% of the Japanese economy.

Market momentum

"I think the overall picture is quite positive," said Richard Jerram, chief economist at Macquarie Securities in Tokyo.

"We're seeing an improvement in output, which seems to be driven by both the export side and the domestic demand side, and we're seeing a gradual diminution of deflation."

A Japanese government report on Monday showed that the country's biggest manufacturers were more confident about the outlook for their companies.

The business survey index of sentiment rose to +6.4 from -2.4 in the three months to the end of September.

Meanwhile, signs of Japan's fresh economic momentum also boosted the country's main stock market.

Tokyo's Nikkei 225 index hit its highest level since May 2001 on Thursday, although the market closed down 0.3% on Friday at 13,547.