The falls come despite recent signs of an improvement in the Japanese economy, which returned to positive growth in the second quarter of 2009, after its worst recession since the second world war.

Why is deflation bad?

Lower prices may seem like a good thing, but the effects of deflation can be highly destabilising.

 Falling prices can hamper growth by depressing company profits and causing consumers to postpone purchases, leading companies to cut production, wages and jobs in turn leading to even lower demand and pressure to lower prices yet further.

 This can evolve into a declining spiral, where consumers continue to put off purchases because they expect lower prices in the future, or because they are worried about their jobs.

 It can also increase debt burdens and the chances that borrowers will default on loans.

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

The latest data suggest the world's second largest economy could face another bout of prolonged deflation.

According to the latest government statistics, the core CPI for the Tokyo area fell 2.1 per cent in September, suggesting that prices nationwide are likely to continue their downward trend.

Prices in the nation's capital are considered a leading barometer of price trends across Japan.

Last month the Bank of Japan said that while some indicators showed signs of recovery, Japanese companies and consumers remained reluctant to spend.

Meanwhile unemployment is continuing to rise, with economists expecting the jobless rate to surpass a record high of 5.7 per cent hit in July.

Boosting domestic demand is a top priority for Japan's new government, voted into power in a landslide election win earlier this month.

Yukio Hatoyama, the new prime minister, has promised cash handouts to families with children, toll-free highways and income supplements for farmers.