Jan. 10 (Bloomberg) -- Goldman Sachs Group cut its economic growth estimate for Japan and said there's a 50 percent chance of a recession in the world's second-largest economy.

``The probability of a recession in Japan has risen to the danger level,'' Tetsufumi Yamakawa, chief Japan economist at Goldman, said in a report to clients today. ``We project weaker- than-expected growth in Japan.''

The nation's economy will continue to slow ``for the time being,'' Bank of Japan Deputy Governor Toshiro Muto said today. The housing slump in the U.S., which Goldman yesterday said may already be in recession, could prompt overseas investors to sell real estate holdings in Japan, Credit Suisse Group said today.

Yamakawa cut his 2008 growth estimate to 1 percent from 1.2 percent, citing slower demand from emerging markets.

Stocks including Mitsubishi Estate Co. declined today after the Credit Suisse report. Japan's leading index, a gauge of growth in the next three to six months, stalled in November, a report today showed.

``Goldman's report highlighting the increasing chances of a recession, as well as the leading index's poor showing, indicates the outlook for external and internal demand is nonexistent,'' said Hiroaki Osakabe, who helps oversee $365 million at Chiba-Gin Asset Management Co. in Tokyo.

Sluggish spending by consumers has left Japan more dependant on overseas markets, just as cooling U.S. demand threatens to spread to Asia, where Japan sells half its exports.

Slashing Interest Rates

Goldman yesterday said slower growth in the world's largest- economy may force the U.S. Federal Reserve to slash interest rates. It predicts the Fed to cut its benchmark rate to 2.5 percent by the third quarter, after saying in November it would reduce the key rate, currently at 4.25 percent, to 3 percent by the middle of 2008.

Earnings gains among Standard & Poor's 500 Index members may have averaged 8.1 percent from a year earlier, the slowest growth in six years, according to data compiled by Bloomberg.

The Bank of Japan probably won't be able to raise its key interest rate, the lowest among industrialized nations, this year because of the recession risk, Yamakawa said. The cycle of rising corporate profits feeding into wages and consumer spending is losing momentum and the bank will conduct policy ``with discretion,'' Muto said in a speech in Sapporo, northern Japan.

`Increasingly Cautious'

``Muto is signaling the Bank of Japan is becoming increasingly cautious about the downside risks for the economy,'' said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo. ``The central bank is already veering from its path of raising rates.''

The yield on Japan's 10-year bond fell 3 basis points to 1.44 percent as of 3:26 p.m. in Tokyo. Muto, 64, is most likely to become governor of the central bank when Toshihiko Fukui's term expires in March, according to 13 of 15 economists surveyed by Bloomberg News last month.

Falling wages, which have dropped about 10 percent in the last decade, and rising food and energy prices have sent consumer confidence to a near four-year low.

``The greatest challenge for the Japanese economy, needless to say, is a recovery in personal consumption, which has remained in an extended slump,'' Goldman's Yamakawa said. ``Innumerable obstacles stand in the way.''

Export Reliance

With domestic consumption flat, the economy is more dependent on foreign demand. Exports contributed almost all of Japan's growth in the third quarter, as demand from Asia helped make up for slowing orders from the U.S.

The risk is that demand from Asia will also dry up.

``A U.S. slowdown affects Asia, beginning with China, and via that route it affects Japan,'' Economic and Fiscal Policy Minister Hiroko Ota said this week. ``The extent to which Japan is hurt depends on the severity of the U.S. slowdown.''

To contact the reporter on this story: Jason Clenfield in Tokyo at jclenfield@bloomberg.net

Last Updated: January 10, 2008 01:40 EST