In a reversal, the government now expects the economy to shrink around 0.5 percent in real terms for fiscal 2014, downgrading its July forecast of 1.2 percent growth, sources said Friday.
If Japan worsens as projected, its inflation-adjusted gross domestic product will shrink for the first time in five years. Fiscal 2014 runs through March 31.
Higher prices triggered by the sharp weakening of the yen and the April 1 consumption tax hike markedly dampened private spending, the sources said.
In nominal terms, however, Prime Minister Shinzo Abe's inflation-stoking administration is expected to project an expansion in fiscal 2014, the sources said.
That means the government will maintain its view that the rate of nominal GDP growth will top the real rate for the first time in 17 years, and that the economy is progressing toward beating nearly two decades of deflation.
In fiscal 2015, Japan's economy is expected to grow about 1.5 percent in real terms and around 2.7 percent in nominal terms, the sources said.
The growth forecasts will be used for the government's tax revenue estimates, one element in its budget planning. The Cabinet plans to approve the fiscal 2015 annual budget next Wednesday.