The Japanese economy shrank in the final three months of 2011, data showed on Monday, as exports were hurt by the strong yen and weak overseas demand while flooding in Thailand hammered production.

On an annualised basis the economy contracted a worse-than-expected 2.3 per cent in October-December, a sharp drop on the previous quarter's huge growth.

The world's number three economy shrank 0.6 per cent quarter-on-quarter, the Cabinet Office said, and 0.9 percent throughout 2011. It grew 4.4 per cent in 2010.

However, ministers and analysts tipped a rebound this year as government reconstruction programmes after the March 11 disasters begin to bear fruit.

Severe flooding in Thailand in the autumn disrupted global supply chains and the production capability of Japanese manufacturers, particularly electronics and automakers, just as they were recovering from the March 11 quake-tsunami disaster at home.

The floods compounded Japan Inc's struggles against a continually strong yen, which is sitting close to record highs against the dollar and is also putting pressure on the euro.

The data come as the country's key export markets in the United States and Europe struggle with huge debt troubles and unemployment as they try to get back on track after the global downturn.

The contraction was more severe than the annualised 1.6 per cent forecast by economists surveyed by Dow Jones Newswires.

It also sharply contrasted to a revised quarter-on-quarter growth of annualised 7.0 per cent for the July-September period, which was in part boosted by post-March 11 reconstruction.

Annualised growth rates reflect the status of the economic trend in a given period, extrapolated as if it had continued for a year. The result allows comparison of data for different time periods.

But Economic and Fiscal Policy Minister Motohisa Furukawa said that despite Monday's figures the economy continued its 'upward movement' with exports and production improving month-on-month in December.

The contraction 'came after external demand was significantly reduced due to the one-off factor of the Thai flooding, which came amid the weak recovery of economies overseas,' he said in a statement.

"Having taken into account (the recovery of exports and production in December) and the overall economic situation, it is assessed that upward movement is continuing," he said.

Forthcoming public programmes to rebuild tsunami-wrecked areas should buoy the economy, which should return to growth in the July-September quarter of 2012, said Yasunari Ueno, chief market economist at Mizuho Securities.

"Public investment is expected to increase in the April-June quarter, thanks to effects of the extra budget," he said.

Exports should also pick up pace as overseas economies are likely to regain momentum, he said.

Slow implementation of a supplementary budget contributed to the latest contraction, said Yuichiro Nagai, an economist at Barclays Capital, who told Dow Jones Newswires: "Our view that Japan's economy will start expanding from the first quarter of this year remains unchanged."

The government in December downgraded its growth forecasts for the year to March 2012 to a contraction of 0.1 per cent but expected a 2.2 per cent expansion in the year from April.