Japanese core consumer prices fell at the fastest annual pace on record in July, potentially putting pressure on a reluctant Bank of Japan to rein in deepening deflation.

The politically sensitive jobless rate also hit a record high 5.7 percent ahead of Sunday's election, which the opposition Democratic Party looks set to win.

Analysts don't expect fresh BOJ action any time soon but some say the Democrats, if they take power, may ask the central bank to maintain very low rates to keep the economy afloat, or even call for more action down the road.

The BOJ was a little bit in denial in the first half of this year, but the CPI data may have them rethink their approach to policy, said Simon Wong, regional economist at Standard Chartered in Hong Kong.

There's no more talk of exit strategy. There may also be pressure to be more aggressive by saying they're committed to current policy until prices turn positive.

The BOJ, however, is unlikely to revert to full-blown quantitative easing and flood the banking system with excess cash as long as price falls narrow in the months ahead, as it doesn't believe deflation is likely to spiral out of control.

Core consumer prices, which excludes volatile fresh food prices but includes oil costs, fell 2.2 percent in the year to July, matching a median market forecast and renewing a record for the third straight month, data showed on Friday.

For a graphic of Japanese, US and Eurozone price moves click:

http://r.reuters.com/zez53d

In a sign deflation is becoming more pervasive, the so-called core-core consumer price index, which strips out food and energy costs, marked its biggest annual fall in seven years.

While price falls will moderate when the base effect of last summer's spike in energy prices fade later this year, weak domestic demand is expected to keep deflationary pressure alive.

The 0.9 percent annual fall in core-core CPI, which is similar to the core index used in other developed countries, was the biggest drop since July 2002 and was the fifth straight month the pace of decline accelerated.

Core consumer prices for Tokyo, available a month before the nationwide data, fell a record 1.9 percent in August from a year earlier, roughly matching market forecasts.

In another sign of weak demand, household spending fell 2.0 percent in July from a year earlier, bigger than a median market forecast for a 0.5 percent fall.

The yen eased slightly to 93.61 against the dollar from about 93.56 before the data.

MORE PRESSURE ON BOJ?

The BOJ is already forecasting two years of deflation and is likely to extend that to three when it issues its twice-yearly outlook report in October.

The bank has said there is no need to act unless the economy falls into a deflationary spiral, in which expectations of price declines so undermine demand that companies cut prices to below cost and cover their losses by slashing jobs and wages, making consumers even less willing to spend.

Many analysts agree with the BOJ that Japan will escape such a spiral because inflation expectations remain stable.

But rising job losses are likely to keep any economic recovery fragile, which could prolong deflation and pile pressure on the central bank for an expanded policy response to the slump triggered by the global financial crisis.

The unemployment number looks very bad, and politicians may increase pressure on the BOJ to do more, as the BOJ as of now does not intend to do more but is thinking about when to begin withdrawing extraordinary measures, said Dariusz Kowalczyk, chief investment strategist at SJS Markets in Hong Kong.

For a graphic of joblessness and household spending click:

http://r.reuters.com/sad63d

A Democrats' win in Sunday's election will likely have no immediate impact, but they might push the central bank to do more and might take an aggressive stance on monetary policy, Kowalczyk said.

The BOJ has taken various unconventional steps to lessen the impact of the global financial crisis, such as buying commercial paper and corporate bonds from banks.

Many market players expect the central bank to extend the programmes beyond their current expiry date in December.

While the BOJ seems very unlikely to return to full-blown quantitative easing, it could instead buy more government bonds or make a commitment to keeping interest rates very low.

A Reuters poll shows analysts expect the BOJ to keep rates steady at 0.1 percent at least until March 2011.

Japan's economy returned to growth in the second quarter, pulling out of its longest postwar recession, but analysts warn of a rocky road ahead as the nascent recovery was based on short-term stimulus efforts around the world.

(Additional reporting by Stanley White, Hideyuki Sano, Rie Ishiguro; Editing by Hugh Lawson)

Inflation Quantitative easing Japan