Japan's government inched toward agreeing new stimulus measures that could be worth $30 billion on Monday as economic growth is likely to slow next year due to sluggish personal spending and rising inventories.

Economists doubt whether that amount will be enough to push growth up significantly as the Democratic Party-led government will likely fund the stimulus with money cut from a budget compiled by the previous administration.

Japan's massive national debt means the Democrats don't have the leeway to spend much more.

The economy grew 1.2 percent in the third quarter, nearly double the forecast and the fastest pace in more than two years, but that was partly due to stimulus that the previous government enacted. The better-than-expected headline figure also failed to mask signs of weakness in private consumption and factory output.

Top government spokesman Hirofumi Hirano told reporters cabinet ministers will discuss fiscal policy on Tuesday, but that won't lead to an announcement on an extra budget.

The Democrats and their two coalition partners agreed not to put a limit on extra stimulus, Banking Minister Shizuka Kamei said. That contradicted Finance Minister Hirohisa Fujii, who earlier said an extra budget won't exceed 2.7 trillion yen, Kyodo news reported.

The government is likely to declare on Friday the economy has returned to deflation, the Nikkei newspaper reported, as the domestic demand deflator fell 2.6 percent in the third quarter from a year earlier, the largest drop in 51 years.

The stimulus would come from what they've cut elsewhere, so the effect on the economy could be close to neutral, said Satoru Ogasawara, economist at Credit Suisse in Tokyo.

Strength in domestic demand will likely continue for the remainder of this year, but we expect some softness in the economy next year.

Japan's gross domestic product (GDP) growth was much faster than the median estimate for 0.7 percent growth and was the largest gain since the first quarter of 2007. It compared with a revised 0.7 percent expansion in the second quarter of this year, which was the first growth in five quarters.

A Reuters poll shows Japan's GDP is expected to slow to 0.1 percent growth in the first quarter next year as stimulus measures fade. The United States and Europe have also emerged from recession but face the same challenge as Japan, namely how to combat weak job creation and downward pressure on prices after stimulus wears off.

MINISTER LEAKS FIGURES

In a headache for Prime Minister Yukio Hatoyama, Trade Minister Masayuki Naoshima leaked the GDP numbers before the embargo time, raising questions about the government's ability to handle confidential information.

December 10-year JGB futures climbed to 138.94 on concern that the economy will lose traction, and then pulled back to settle 0.02 point lower at 138.86.

The economy is expected to continue to recover as overseas economies improve, National Strategy Minister Naoto Kan told reporters after the data.

At the same time, the employment situation remains very bad and downside risks exist in overseas economies.

Kan added that he saw signs of deflation and wanted to work closely with the Bank of Japan to avoid deflation from deepening. Deflation can cause consumers and businesses to delay purchases, dragging the economy down further, but Japanese policy makers may have little success in causing prices to rise given the large gap between supply and demand.

Private consumption rose 0.7 percent, better than a forecast for a 0.5 percent rise but slower than a 1.0 percent increase in the previous quarter.

Domestic demand contributed 0.8 percentage point to growth, the first positive contribution in six quarters.

CAPITAL SPENDING UP

Subsidies and tax breaks enacted by the previous government helped private consumption, but the pace of the rise was slower than the quarter before and an expected fall in year-end bonuses and a soft labor market mean households will have less to spend.

With weakness ahead in private consumption or public spending, a slowdown is unavoidable in the January-March and April-June quarters, said Kyohei Morita, chief economist at Barclays Capital in Tokyo.

The one bright spot is that capital spending turned positive. However, while this signals that capital spending is starting to rise from the bottom, the size is still not enough to promise the kind of speed that would be required to prevent a slowdown in the first half of 2010.

Capital expenditure rose 1.6 percent, the first gain in six quarters and faster than a 0.1 percent increase forecast by economists. In an ominous sign for manufacturing, inventories started to increase, contributing 0.4 percentage point to growth in the third quarter, the first positive contribution since the fourth quarter last year.

Companies have been increasing production for about a year now, and inventories are likely to start piling up toward year-end and around the Chinese New Year, said Yasuo Yamamoto, senior economist at Mizuho Research Institute in Tokyo.

This could lead to a slowdown in Japanese production and Japanese growth in April-June 2010.

Most economists say there is little chance of Japan's economy, which extended its rebound to a second quarter, returning to recession as stimulus spending overseas should support export demand.

Japan's exports rose 6.4 percent in the third quarter, matching their increase in the previous three months.

($1=89.64 Yen)

(Editing by Hugh Lawson)

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