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TOKYO (Kyodo) -- The Japanese economy shrank an annualized real 3.7 percent in the first quarter of the year, much worse than market forecasts, further indicating that the March 11 earthquake and tsunami have seriously damaged the sentiment of companies and households toward spending, the government said Thursday.

Analysts and government officials shared the view, however, that the contraction in the world's third-biggest economy should be milder in following quarters and that even a strong rebound may be possible.

The rate of fall in January-March gross domestic product was sharper than the average market forecast of a 2.3 percent contraction in a Kyodo News survey. The result corresponded to a 0.9 percent slide from the previous quarter, weaker than economists' projection of a 0.6 percent decline.

The figure in real terms, adjusted for inflation, represented the second consecutive quarter of decline following a downwardly revised 0.8 percent contraction in the October-December period, the Cabinet Office said in a preliminary report. GDP is the total value of goods and services produced domestically.

In fiscal 2010 ending March, GDP gained a real 2.3 percent for the first expansion in three years, mainly supported by the government's fiscal stimulus packages, which had temporarily boosted consumer spending.

Private consumption, which makes up some 60 percent of Japanese GDP, dropped 0.6 percent in the January-March period for the second straight quarterly decline as spending on durable goods, especially cars, fell sharply. The office said the result reflected a considerable slowdown in industrial output, triggered by natural disaster.

With the supply of key components disrupted nationwide, manufacturers' inventories declined, pushing GDP lower by 0.5 percentage point.

"The first-quarter GDP dropped at a rather faster rate than forecast," said Masaaki Kanno, chief economist at JPMorgan Securities Japan Co. The result showed how badly the economy was damaged by the earthquake, he said.

But Kanno also mentioned the possibility that the economy may have "reached the bottom earlier than initially thought," suggesting the impact on the economy from the disaster could be milder in the second quarter. "We can expect a strong rebound down the road."

Economic and fiscal policy minister Kaoru Yosano told reporters that the economy may perform only weakly for a while. But he also said, "The supply disruptions are being addressed. It will not be long before we see a recovery in (consumer) sentiment...and a surge in (domestic) demand as a result of reconstruction work."

In the reporting quarter, the services sector suffered from less spending by consumers who have cut entertainment expenditure amid the mood of self-restraint following the earthquake, it said.

Corporate capital investment slipped 0.9 percent, the first decline in six quarters, as spending by companies on such purposes as new vehicle purchases decreased. Public investment fell 1.3 percent while housing investment by the private sector was up 0.7 percent.

Exports grew 0.7 percent on robust growth in emerging market economies, especially those in Asia. Imports increased 2.0 percent amid higher oil and other commodity prices.

Trade pushed GDP lower by 0.2 percentage point, while domestic demand subtracted 0.8 point from the growth rate.

On a nominal basis, or before adjustment for price change, GDP fell an annualized 5.2 percent in the January-March period, which corresponds to a 1.3 percent contraction from the previous quarter. The GDP deflator, a wider gauge of inflation than consumer price index, lost 0.4 percent for the fourth consecutive quarter of fall, adding to the evidence that the country has been mired in mild deflation.

In fiscal 2010, the GDP deflator tumbled 1.9 percent, the biggest fall since comparable figures became available in 1956.