TOKYO: Japan's central bank said Wednesday it was extending its emergency measures to tackle the worst recession in decades, as it downgraded its outlook for the world's number two economy.

But the Bank of Japan said the slump was easing and economic conditions "have stopped worsening."

"The current financial and economic situation is still severe, but we've seen clear signs of an improvement," central bank governor Masaaki Shirakawa told a press conference.

At the same time, however, "domestic demand remains weak," he added.

The Bank held its key interest rate steady at 0.1 percent, as expected, and said it would continue its policy of buying up corporate debt to keep credit flowing to cash-strapped firms during the recession.

The programmes, which were due to expire at the end of September, were extended for the rest of 2009. The BoJ also extended a currency swap agreement with the US Federal Reserve until February 1.

While there are hopes the recession is easing, gross domestic product is expected to shrink 3.4 percent in the financial year to March 2010, worse than a previous forecast for a contraction of 3.1 percent, it said.

The Bank also revised its outlook for the next financial year, predicting positive growth of 1.0 percent, against a previous projection of 1.2 percent.

It said the economy should start recovering from the second half of this financial year, supported by policymakers' efforts to tackle the economic downturn and a credit crunch.

However, Shirakawa cautioned that uncertainty lingered, declining to outline a possible "exit strategy" from its emergency pump-priming measures.

Japan entered recession in the second quarter of 2008 as its heavy dependence on overseas demand to drive growth left it highly exposed to the global downturn.

The economy shrank at an annualised pace of 14.2 percent in the first quarter of 2009, the worst performance on record, but recent data have indicated that exports and industrial production have begun to rebound.

"Public investment is increasing and exports and production are picking up," the BoJ said in a statement.

"Business sentiment, especially of large manufacturing firms, has stopped deteriorating. On the other hand, business fixed investment is declining sharply mainly reflecting weak corporate profits," it added.

Concerns are also growing about the prospect of another bout of deflation in Asia's largest economy.

Consumer prices are expected to fall 1.3 percent this financial year and by 1.0 percent next year, the BoJ said.

Japan was stuck in a deflationary spiral for years after an economic bubble burst in the early 1990s, prompting consumers to put off purchases in the hope of further price drops and reducing corporate earnings.