TOKYO: Japan's worst post-war recession appears to be easing, the central bank said Friday as it upgraded its assessment of the world's number two economy for the first time in almost three years.

"We are now gradually leaving the situation where things are in freefall," said Bank of Japan (BoJ) governor Masaaki Shirakawa.

Japan's economy suffered its sharpest contraction on record in the three months to March, with gross domestic product (GDP) shrinking 4.0 percent compared with the previous quarter.

Hopes are growing that the slump will mark the trough in the recession.

"Our expectation is that the April-June GDP growth figure will show a significant improvement compared to the January-March figure," Shirakawa told reporters after the BoJ left its key interest rate on hold at 0.1 percent.

But he added: "The outlook remains highly uncertain. We have to carefully monitor the situation by paying close attention to downside risks."

With little room left to reduce rates further, the BoJ is turning to alternative tools to spur lending.

It said Friday it was expanding the type of debt it will accept from banks in return for emergency funds to include bonds issued by the governments of the United States, Britain, Germany, and France.

"Economic conditions have been deteriorating, but exports and production are beginning to level out," it said in a statement.

"Going forward, although domestic private demand is likely to continue to weaken, exports and production, after levelling out, are expected to start recovering and public investment to increase.

"Therefore, the pace of deterioration in economic conditions is likely to moderate gradually, leading to a levelling out of the economy," it said.

The assessment was brighter than its April view that economic conditions had "deteriorated significantly," marking the first upgrade since July 2006.

The BoJ last month predicted Japan's economy would shrink 3.1 percent in this fiscal year to March, more than previously expected.

But the pace of decline in exports and production would slow, paving the way for 1.2 percent growth in the next fiscal year, it said

Japan -- which suffered a decade-long economic slump in the 1990s -- posted an unprecedented fourth straight quarter of negative growth in the three months to March.

Japan's exporters have been hit particularly hard by the current global downturn because they produce big ticket items such as cars and televisions that are typically bought on credit by consumers in developed nations.

The country's auto and high-tech giants have announced massive job cuts in recent months as they sink deep into the red due to the slump in exports.

But most analysts think the economy will stabilise in the current quarter, possibly even returning to positive growth. Exports and factory output both rose slightly in March from the previous month.