TOKYO - Japan's government raised its assessment of the economy for the second straight month and said the world's No.2 economy has bottomed out as exports and factory output recover from sharp declines.

The government lowered its outlook on capital expenditure, however, after Finance Ministry data earlier this month showed corporate spending posted a record fall in the first quarter from a year earlier, signalling that weak domestic demand will weigh on the recovery from the worst recession since World War Two.

"While the economy is in a difficult situation, movements of picking up are seen in some areas," the Cabinet Office said in the monthly report released on Wednesday.

The report omitted an expression used to describe the economy last month, when it said "the pace of deterioration is slowing".

The upgrade is equivalent to saying Japan has hit bottom but further weakness cannot be ruled out, a Cabinet Office official said.

The Bank of Japan also upgraded its assessment of the economy on Tuesday, saying it has begun to stop worsening and will likely show clearer signs of levelling out in the coming months.

The government upgraded its view on exports and industrial production, saying shipments to other parts of Asia are showing signs of improving and factory output is recovering.

The government raised its assessment of consumer spending for the first time in two years, citing improvements in consumer sentiment, but warned that employment is still worsening rapidly.

The report said capital expenditure is now shrinking a lot, compared to last month when it just said it was shrinking. The outlook is likely to be weak as corporate earnings are falling, it said.

Finance Minister Kaoru Yosano said earlier this month that the first quarter marked a bottom and the pace of recovery depends on demand for Japan's exports.

In contrast, Bank of Japan Governor Masaaki Shirakawa refused to be drawn on the issue on Tuesday, instead emphasising his pessimism about domestic demand after the central bank lifted its assessment of the economy.

For the coming months, the Cabinet Office said Japan can be expected to head toward a recovery path as overseas economies are improving, there is less pressure from inventory adjustments, and as economic stimulus measures take hold.

Risks to this scenario are that the extremely low level of production activity poses a threat to employment and there are also downside risks to the world's economy.

Japan's economy is expected to grow 0.5 percent in the second quarter after shrinking a record 3.8 percent in January-March, a Reuters poll showed.