The government on Friday downgraded its overall economic evaluation for the second consecutive month, saying the nation's recovery appears to be stalling on weak production stemming from the U.S. economic slowdown.

In its latest monthly report on the economy, the Cabinet Office also said Japan is in a state of mild deflation due to continued falls in consumer and wholesale prices.

It is the first time since the end of World War II that the government has officially acknowledged the economy is in the grip of deflation.

Taro Aso, minister in charge of economic and fiscal policy, told reporters that deflation will negatively affect the economy. "If consumers think prices will fall, they will refrain from making purchases, so there will be less personal consumption," he reckoned.

"Corporate sentiment will become negative if sales go down," he warned.

In the monthly report for March, the Cabinet Office said, "The economic recovery appears to be pausing."

The report, however, claims the economy's move toward a self-sustaining recovery is intact due to sound corporate earnings and capital spending.

The government last used the term "pausing" in January 1998. The latest report marks the first time since September 1998 that the government has revised down its assessment for a second straight month.

A Cabinet Office official said weak production stemming from the U.S. economic deceleration is largely responsible for the downgrade.

"Reflecting the slowdown of the U.S. economy, Japanese exports have faltered, with the result that industrial production has weakened in recent months," the Cabinet Office report says.

The report gives a dim outlook for the economy, pointing to lingering concerns about the U.S. slowdown and signs that corporate capital spending will decelerate.

The official said that concerns over the slowdown of Asian economies and the volatility of stock prices were also factors behind the gloomy assessment.

In the March report, the Cabinet Office revised down its assessment of exports, production and employment, saying exports have been falling and production has been weak while the unemployment rate has remained at a record high with the trend of increasing job offers stalling.

As for personal consumption, key to a full-fledged economic recovery, the Cabinet Office left unchanged its assessment that it is broadly flat.

The official said there were some bright spots for consumption, including increased sales of winter clothes due to the cold weather and last-minute purchases of appliances ahead of a new recycling law to take effect in April.

he warned that there are concerns that consumption may weaken once these factors have passed.

Noting that consumer and wholesale prices remain weak, the Cabinet Office said the economy is in a state of mild deflation.

It has decided to define deflation as "a state in which prices keep falling," deviating from Japan's official definition of deflation as "a state in which prices are falling while the economy is receding."

The consumer price index for the whole of Japan dropped 0.3 percent in 1999 from a year earlier and then 0.4 percent in 2000, government statistics show.

The official said it was the first time since the end of World War II that prices dropped for two years in a row.

He also said Japan is the only country among the member states of the Organization for Economic Cooperation and Development that is experiencing continuous price falls.