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The government on Monday raised its assessment of the economy for the first time in more than three years, citing a gradual pickup in external demand and falling corporate inventories, possibly indicating the worst of the recession is over.

“While the economy is in a difficult situation, the tempo of worsening has become moderate,” the Cabinet Office said in its monthly economic report for May.

It is the first time since February 2006 the government has upgraded its overall assessment of the economy, abandoning the wording it used over the past two months, when it said, “The economy is worsening rapidly while in a severe situation.”

It noted that some economic indicators, including those related to industrial output and exports, have improved, while others such as those gauging the health of consumer spending and housing markets have shown signs of leveling out.

The government expected the economy to be backed by strengthening economic conditions abroad, especially in China, the ongoing progress in inventory adjustment and the effects from a huge package of stimulus measures, which include tax cuts for the purchase of environmentally friendly cars and expressway toll discounts.

But the report says the economy remains vulnerable for the time being, warning in particular that deteriorating job conditions could be the next big obstacle to recovery.

The government lowered its assessment of employment conditions for the first time since December, when it said for the first time ever that they were “getting worse rapidly.”

Now it says, “The employment situation, which is worsening rapidly, is severe.”

The seasonally adjusted unemployment rate in March, released earlier this month, rose at its fastest pace in more than 40 years to hit a four-year high of 4.8 percent.

Because salaries have also been cut, Cabinet Office officials are concerned about a possible renewed slowdown in consumer spending, a key driver of domestic demand.

In the latest monthly economic report, the government kept the assessment for consumer spending unchanged for the fourth straight month, saying it is “decreasing modestly.”

On the outlook of private consumption, the report says the impact of the swine flu outbreak must be watched carefully.

Its evaluations of all economic areas, except the job environment, were either upgraded or kept intact.

The assessment of industrial production was upgraded for the first time since December 2007, saying it is “nearing the bottom,” while that of bankruptcies improved for the first time since June 2004.

The description of capital spending remained “decreasing” for the sixth consecutive month.

On the economic climate overseas, the government upgraded its overall view for the first time since December 2003, saying there are some positive effects arising from policy responses and fewer risks, although the situation remains severe.

The United States, Asia and the euro zone all received higher grades for their economic conditions.

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