TOKYO -- Production at Japanese factories fell by a record 10 percent last month and jobs proved increasingly hard to find, showing Japan's worst recession since World War Two is deepening.

Annual core consumer inflation evaporated, government data showed on Friday, as cheaper oil drives the world's second-biggest economy back towards deflation less than two years after it escaped the last spell of falling prices.

With factories forecasting a further drop in output in February, analysts polled by Reuters said the economy was headed for its second big contraction in a row in the first quarter.

While a drop in inventories offered a glimmer of hope for the battered manufacturing sector, grim jobs data and a slump in household spending showed the pain first felt by exporters was spreading across the economy.

"The downturn led by manufacturers may ease after the first half of this year," said Takeshi Minami, chief economist at Norinchukin Research Institute. "But it will gradually spread to non-manufacturers, making Japan's economic gloom a long one." The economic woes and political infighting that is delaying government stimulus efforts, have taken the yen to 3-1/2-month lows as investors lose confidence in a currency once seen as a haven from the global financial crisis.

Employment data for January showed new job offers fell 18.4 percent from a year earlier, while the ratio of jobs to applicants hit a five-year low of 0.67, meaning there were only two jobs for every three applicants.

Discouraged workers are leaving the workforce, officials say, and the tough times prompted households to cut their spending by 5.9 percent in January from a year earlier.

The yen slid nearly 12 percent from a 13-year peak of 87.10 per dollar reached last month. It pulled back from Thursday's lows on Friday to stand around 98 to the dollar.

The strong yen has contributed to a roughly 15 percent slide in the Nikkei share average so far this year, hitting exports and profits on overseas sales. But Finance Minister Koaru Yosano told reporters the yen's retreat might not offer much of relief to exporters given the global slump in demand.

DEFLATION ROUND THE CORNER

Rising utility bills prevented an expected drop in the core consumer price index in January, but economists said it was only a matter of time before core prices, which exclude volatile fresh food but include oil, began sliding.

The Bank of Japan says it expects two years of falling prices but economists debate whether it will take the form of chronic deflation -- where price falls lead shoppers to hold back, pushing prices down further.

Manufacturers' forecasts for output to the end of March point to a record 22 percent slide in industrial output for the quarter, almost double the previous quarter's 12 percent fall, as exports of cars, auto parts and electronics tumble and factories try to clear stocks of unsold goods.

That will feed into another big economic contraction this quarter, a Reuters Poll found. Analysts forecast a fall of around 10 percent annualised in the three months to March after a 12.7 percent fall in the final quarter of last year.

The fourth-quarter slump marked the deepest contraction in Japan since 1974 and was three times as sharp as the U.S. economic contraction and more than double the rate at which the euro zone retreated in that quarter.

EYES ON INVENTORIES

There was a glimmer of hope in a 2 percent fall in inventories, suggesting production cuts that have taken factory output back to levels seen in the 1980s were starting to bring output back in line with sharply lower demand.

Nissan Motor Co said on Thursday it would scale back some production cuts next month and the world's No.1 car maker, Toyota Motor Corp, plans to take similar modest steps in May -- although output will still be well below usual levels.

While the global financial crisis has dragged much of the rich world into recession, Japan has been among the hardest hit as it relies heavily on exports for growth.

Economists said they expected the Bank of Japan to take more steps to ease a credit squeeze plaguing businesses and driving up bankruptcies, but that it was up to the government to kick-start the economy.

"The Japanese government needs to hurry on fiscal policy to address the worsening gap between supply and demand," said Yasuo Yamamoto, senior economist at Mizuho Research Institute.

The lower house of parliament approved a record annual budget on Friday but squabbling has held up other stimulus efforts, with opposition parties able to stall legislation in the upper house to try to force an early election they are well placed to win.