A government spokesman said he thought the recovery would start soon, but most economists predict the slump continuing through this year and into 2000. The yen weakened below 120 to the dollar on the news.
Elsewhere, the euro retreated from the levels it touched after the resignation of Oskar Lafontaine, but remained around $1.09. Shares in Frankfurt soared 6 per cent at one stage, the DAX index passing the 5,000 level. It ended at 5,031.06.
The Dow Jones Industrial Average failed to breach the 10,000 mark, however, despite further good news on the US economy. Shares in London ended nearly 54 points lower at 6,282.2.
The 0.8 per cent drop in Japan's GDP in October-December took it 2.8 per cent down year-on-year. Forecasters expect another 2-2.5 per cent decline in the economy this year.
The slump last year would have been much worse without the government's programme of public works. Public spending contributed 0.7 per cent to growth in the final quarter.
But every other category of national output - private investment, consumer spending, stocks and net trade - made a negative contribution to growth.
Taichi Sakaiya, head of the Economic Planning Agency, said: "With all the measures the government has taken and with interest rates having been cut so low, I personally think consumption will pick up."
But Matthew Wickens at ABN-Amro said: "Much more needs to be done on the policy front to achieve sustained growth."
The Bank of Japan left its policies unchanged after its council meeting yesterday. It will continue to keep the key short-term policy rate of interest close to zero.
Many analysts argue that it will have to taken even more aggressive steps to reflate demand - such as buying in government bonds in exchange for newly-minted cash. This would get more money into circulation and would also help reverse the recent upward jump in long-term interest rates.
However, yesterday Japan did take the next step in the reform of its banking system with formal approval of a 7.46 trillion injection of public money into 15 top banks.
The Government will buy a combination of preference shares and subordinated debt in the banks, with Fuji Bank getting the biggest amount at 1 trillion.
The recapitalisation of the banks is a precondition for an end to the credit crunch. Banks have been unwilling to make loans because of the fragility of their capital ratios.
Even if such measures do help to kick-start an eventual recovery, Japan is overshadowed by longer-term concerns. Its population is ageing more rapidly than that of any other Group of Seven country, and the huge potential pensions bill means the government deficit could explode in future.