As cooling exports and flat domestic consumption hit Japan's growth in April-June, the data pointed to the looming prospect of China overtaking Japan as the world's second-largest economy.

"The economy is levelling off," said Keisuke Tsumura, parliamentary secretary of the Cabinet Office.

Japan's real gross domestic product grew by an annualised 0.4 percent in the quarter, down from a revised 4.4 percent in the previous three months, missing forecasts of 2.3 percent growth in a Dow Jones Newswires economists' poll.

On a quarterly basis, growth was at 0.1 percent, down from a revised 1.1 percent in the previous quarter.

"It was a negative surprise," said Yoshiki Shinke, Dai-Ichi Life Research Institute senior economist.

The figures pose a challenge for Prime Minister Naoto Kan's government, which must balance a fragile economy with an agenda focused on cutting the industrialised world's biggest public debt, at nearly 200 percent of GDP.

However, Monday's data "make it even less likely that the government will move quickly to tackle the huge public debt," said Julian Jessop of Capital Economics in a research note.

Private consumption, a key driver of the economy, was flat after growing 0.5 percent in the previous quarter.

Net exports contributed to 0.3 percent of GDP from 0.6 percent previously, fuelling fears of a global economic slowdown.

Many analysts say 2010 is the year China will replace Japan as the world's second-largest economy, with data showing that while Japan stayed ahead of its Asian rival in the first half, it fell behind in April-June.

On a nominal basis, Japan's second quarter GDP was smaller than China's, at 1.288 trillion dollars compared with 1.336 trillion dollars, according to the government.

If the trend continues, as many expect, China will this year become the world's number two economy, just behind the United States -- taking the title Japan has held for 40 years and underscoring its emergence as an economic power.

In just three decades since opening its doors to foreign investment, China has leapfrogged Britain, France and Germany on its economic ascent and has won developing countries a bigger say in the World Bank and International Monetary Fund.

Whereas despite it crawling out of a severe year-long recession in 2009, Japan's recovery remains fragile with deflation, high public debt and weak domestic demand all concerns for policymakers.

Japanese officials stressed full-year figures would give a clearer picture in early 2011, while analysts said questions over the clarity of Chinese data remained.

"If China's under-reported service sector output was properly measured, or simply if Hong Kong was included in the total, China would have overtaken Japan some time ago," noted Jessop.

According to Yi Gang, Beijing's vice-governor of the central bank and head of the foreign exchange regulator, China achieved that economic milestone before Monday's Japanese growth figures.

Japan stayed ahead in the first half, with nominal gross domestic product at 2.578 trillion dollars, slightly higher than China's 2.532 trillion dollars, the cabinet office said.

China's nominal quarterly GDP has twice previously been greater than Japan's in dollar terms -- in the fourth quarters of 2008 and 2009 -- though its nominal GDP in 2009 was still below Japan's 5.07 trillion dollars at 4.98 trillion.

Analysts are pointing to an even tougher second half for Japan as it is increasingly buffeted by global economic headwinds.

According to data compiled by the Nikkei business daily, the median forecast from six analysts polled saw Japan's growth in fiscal 2010 downgraded to 1.9 percent from 2.6 percent in fiscal 2010.

The export sector, crucial to Japan's fragile recovery, is also anxious about the strength of the yen, which recently touched a 15-year high against the dollar, hitting repatriated overseas profits and prompting verbal intervention from government officials.

In Tokyo the Nikkei 225 index closed 0.61 percent lower.

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