Japan Q2 output gap narrows from record

TOKYO (Reuters) - Japan's output gap narrowed in the second quarter from a record in the previous quarter, but supply continued to outstrip demand by a large margin in a sign of persistent deflation.

The output gap was minus 7.4 percent in April-June compared with a revised minus 8.0 percent in the January-March quarter, the Cabinet Office said on Monday. The first-quarter figure was initially estimated at minus 8.5 percent.

The output gap shows how much gross domestic product deviates from potential GDP, or the volume of activity when the economy is running at full capacity.

The size of the gap suggests deflationary pressures remain strong in Japan. Data last week showed that core consumer prices, which exclude fresh food, fell at the fastest annual pace on record in July, while the unemployment rate jumped to a postwar high of 5.7 percent in July, signaling further weakness in final demand.

The Bank of Japan, which has kept its benchmark interest rate at 0.1 percent since December, sees the output gap as a key variable for determining monetary policy and gauging price conditions. A negative output gap means there is less pressure on prices to rise.

A longer spell of deflation could deter the BOJ from raising the key rate and warrant an expanded policy response to the slump triggered by the global financial crisis.

(Reporting by Rie Ishiguro; Editing by Michael Watson)