Oct. 30 (Bloomberg) -- Japan’s consumer prices fell at a near-record pace in September, a sign that deflation is likely to remain a drag on the economic recovery.

Prices excluding fresh food slid 2.3 percent from a year earlier after dropping an unprecedented 2.4 percent in August, the statistics bureau said today in Tokyo. The median estimate of 28 economists surveyed was for a 2.4 percent decline.

Companies are cutting prices to attract customers whose wages are tumbling. The Bank of Japan will probably forecast today that consumer prices will keep falling through fiscal 2011, signaling there will be little chance to raise interest rates for a year at least, economists said.

“The economy’s momentum will definitely remain weaker than last year and continue to weigh on demand,” said Kiichi Murashima, chief economist at Citigroup Global Markets Ltd. in Tokyo. “Globally, companies are feeling they can’t keep their market share unless they take part in this discounting race.”

Other reports today showed Japan’s recovery may be solidifying. The unemployment rate unexpectedly declined to 5.3 percent from a record 5.7 percent only two months earlier. The ratio of jobs for each applicant rose for the first time in more than two years. Household spending climbed 1 percent.

The yen traded at 91.51 per dollar at 8:52 a.m. in Tokyo from 91.47 before the reports. Japanese stock futures opened higher after a U.S. report showed the world’s biggest economy grew for the first time in more than a year last quarter.

BOJ Outlook

Central bank policy makers will release their semiannual outlook for the economy and prices at 3 p.m. in Tokyo. The board members are likely to stress they will have to keep borrowing costs near zero to bolster economic growth.

“The outlook report will likely warn that risks to the economy are still to the downside and core prices will remain below zero,” said Izuru Kato, chief market economist at Totan Research Co. in Tokyo. The report will help to quash any investor expectations that rates may rise soon, he said.

The central bank will keep the benchmark overnight lending rate at 0.1 percent at least through the end of 2010, according 15 of 16 economists surveyed by Bloomberg last week. Governor Masaaki Shirakawa said this month the bank will maintain “very low” interest rates to ensure the recovery will be sustained.

Retailers are cutting prices more aggressively to attract consumers whose wages have slid for 15 months.

Cheaper Jeans

Don Quijote Co., a discount store operator, started selling jeans for 690 yen ($7.50) this month, undercutting Aeon Co. and Seiyu Ltd., Japan’s two largest supermarket chains, which have been offering them for about $9. Fast Retailing Co., the operator of Uniqlo stores, began the battle in March with pairs at $11.

Seiyu, which is owned by U.S.-based Wal-Mart Stores Inc., also started to market a business suit for men for 5,000 yen this month.

“We’ve been observing deflation in food, and now it’s spreading to clothing,” said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo. “Retailers are trying to respond to households’ efforts to pare back basic expenditure, and that’s fueling deflation in daily necessities.”

Much of the drop in consumer prices reflects last year’s peak in oil costs. Crude has dropped more than 40 percent since it reached an unprecedented $147.27 a barrel last July.

Even though the oil effect will wane in coming months, weakening demand will continue to pull down consumer prices, said economist Yoshiki Shinke.

“The pace of declines will keep slowing, and we’ll see that more clearly from October,” said Shinke, a senior economist at Dai-Ichi Life Research Institute in Tokyo. “Even so, core prices won’t surface above zero through 2010.”

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

Last Updated: October 29, 2009 19:53 EDT