UPDATE 3-Japan Oct machinery orders slump, show recovery stalling

* Core orders slump 6.9 pct vs 0.5 pct fall expected

* Euro zone crisis, global slowdown herald further weakness

* Japan may hit soft patch through early 2012 - analyst

By Tetsushi Kajimoto

TOKYO, Dec 8 (Reuters) - Japan's core machinery orders fell much faster than expected in October, suggesting firms are slashing capital spending as a deepening euro-zone debt crisis and yen strength cast a pall over the economy's tentative recovery.

Core machinery orders, a highly volatile data series regarded as an indicator of capital spending in the coming six to nine months, slumped 6.9 percent in October from the previous month, government data showed on Thursday.

The fall compared with a median market forecast for a 0.5 percent drop and follows an 8.2 percent slump in September, leaving orders just 1.5 percent above year ago levels.

While Japan has pulled out of a recession triggered by the March earthquake, a slump in exports and business sentiment, plus Thursday's machinery orders data add to growing signs of malaise in the world's third-biggest economy.

"Machinery orders won't continue to fall but instead are likely to stagnate. We won't have a recession. However, growth is likely to be very slow," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management Co.

Core orders fell below 700 billion yen ($9 billion) for the first time this year. Corporate spending has been struggling to recover to levels seen before the 2008 collapse of Lehman Brothers, which triggered the last global financial crisis.

"Machinery orders are flattening as uncertainty has heightened since the summer due to Europe's debt crisis, U.S. slowdown and the yen's rise," a government official said.

SOFT PATCH

Takeshi Minami, chief economist at Norinchukin Research Institute, said two quarters of shrinking economic output -- technically defined as a recession -- could not be ruled out even though he referred to it as a "soft patch" rather than a serious downturn.

"Given rapidly slowing global economy and declining Japanese exports, the economy may contract slightly in October-December and January-March, until it gets a boost from reconstruction-related public spending in April-June," he said.

Japanese manufacturers are also trying to cope with a strong yen, compounding their concerns over the weakness of overseas demand.

The yen hit record highs against the dollar in October, prompting Japanese authorities to spend a record amount intervening in currency markets to stifle its gains in an effort to help exporters.

October trade and current account data highlighted the pain with the current account surplus marking its eighth month of sharp annual declines and the trade balance swinging into a deficit.

The currency is now 2 yen below its record high of 75.31 per dollar. But traders expect the currency to continue drawing steady demand as a safe-haven for investors worried about Europe's debt crisis.

In a sign of further weakness in corporate spending, Japan's manufacturers turned pessimistic for the first time in six months on the euro zone crisis and global slowdown, a Reuters survey showed on Wednesday. The survey is highly correlated with the Bank of Japan's quarterly tankan report.

Underlining sluggish business expenditure, Japanese bank lending rose a meagre 0.2 percent in November from a year earlier, posting the first annual gain in two years.

Companies surveyed by the Cabinet Office last month forecast that core machinery orders will fall 3.8 percent in October-December, after increasing 1.5 percent in the previous quarter, and the latest data reinforce such a scenario.

Japan's economy grew briskly in the third quarter, rebounding from a slump triggered by the devastating March 11 earthquake. But it is expected to slow sharply this quarter.

The Bank of Japan loosened monetary policy in October to ease the pain from yen rises and global uncertainty, and has expressed its readiness to act again if risks to Japan's recovery materialise. The board next meets for a policy review on Dec. 20-21.