Consumers are closing their wallets as the economy’s outlook darkens, making it harder for Prime Minister Yoshihiko Noda to stave off the nation’s third recession in four years.

Households are holding the most cash since 2005, shunning risk as they grow gloomier, Bank of Japan data indicate. Sliding private consumption contributed to an annualized 3.5 percent decline in gross domestic product in the past quarter, a Cabinet Office report showed Monday.

While Noda may avoid a fiscal cliff as the opposition becomes increasingly open to a deal on deficit-financing legislation, the consumer malaise highlights the challenge of reviving growth in the world’s third-largest economy. At the same time he tries to rebuild relations with China to support exports, Noda may need to come up with more incentives for consumer purchases at home.

“The Japanese government has no choice but to implement additional measures to shore up the economy,” said Junko Nishioka, chief economist at RBS Securities Japan Ltd and a former BOJ official. “The dispute with China, the decline of the stock market, and confusion over the political situation in Japan are hurting confidence.”

Sentiment on the economic outlook was the weakest last month since the aftermath of the 2011 earthquake and tsunami, a government survey showed, with the end of car subsidies and the looming consumption tax increase also making people more pessimistic.

Japan risks its third textbook-definition recession since 2008, meaning two straight quarters of contraction. The median forecast in a survey of economists by Bloomberg News is for an annualized 0.4 percent contraction in the September-December period. Japanese recessions are officially defined by a government-charged panel that considers data beyond GDP figures.

“We need a firm response considering the grim outlook for the Japanese economy,” economic and fiscal policy minister Seiji Maehara told reporters Tuesday. He declined comment on the size of any new fiscal stimulus measures.

Consumption in the third quarter dropped at an annual rate of 1.8 percent after a 0.4 percent fall in the previous three months, the first back-to-back decline since the global financial crisis, Monday’s report from the Cabinet Office showed.

The main index in the government’s Economy Watchers Survey, which looks at how people feel about the outlook for the next two to three months, fell to 41.7 in October, the lowest level since the aftermath of last year’s earthquake. A figure under 50 indicates that more people see conditions deteriorating than improving.

Respondents to the survey included a travel agent in the Tokai region who complained that the territorial disputes with China and South Korea were deterring people from traveling abroad.

A car salesman in Shikoku said the end of government subsidies for fuel-efficient cars was hurting business, while a supermarket manager in the same region noted concerns among shoppers over a planned doubling of the consumption tax.

The government announced on Oct. 26 a ¥750 billion stimulus package to shore up growth, the scope of which was limited by the political standoff that is blocking legislation to allow borrowing to pay for this year’s deficit. The measures compare with more than ¥20 trillion in spending to boost the economy and pay for rebuilding budgeted after the March 2011 disasters.

“The government has few tools to boost the economy, as its term will end soon, the budget deficit is so huge and political paralysis means it’s hard to agree on measures,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management.

The Liberal Democratic Party is likely to accept a deal offered by the ruling Democratic Party of Japan to end the stalemate over legislation to fund the rest of this year’s budget, LDP policy chief Akira Amari said Monday.

Worsening sentiment may be filtering through to the investment market, with BOJ data for this year showing that holdings of securities such as stocks, bonds and investment trusts as a proportion of household assets are at their lowest since 2005.

“People have no incentive to take risks,” said Masamichi Adachi, a senior economist at JPMorgan Securities Japan Co. and a former central bank official. “They are just putting money into banks, and it’s very unlikely they will move to securities in the future.”

Companies are cutting jobs and trimming pay as profits fall. Renesas Electronics Corp., the world’s largest microcontroller maker, plans to cut thousands of jobs, while TDK Corp., a manufacturer of electric components, will shed 1,000 domestic positions. Sharp Corp., Panasonic Corp. and Sony Corp. posted record losses last year and are cutting jobs and production lines in a bid to return to profitability.

Large businesses cut winter bonuses by 2.7 percent from last year to ¥781,396, according to a report last week by the Keidanren association of businesses.

Machinery orders, an indicator of capital spending, fell the most in four months in September, data showed last week, while industrial production slid the most since the earthquake and exports dropped 10.3 percent in the same month.

Net exports, or shipments less imports, subtracted 0.7 percentage point from GDP on a quarterly basis, the biggest decline in three quarters.

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