The Nikkei 225, Japan’s headline stock index fell by 2.96 per cent on the day’s trading, ending its recent impressive rally.
Meanwhile, the dollar reached a seven-year high against the yen before settling down later on.
GDP contracted by 0.4 per cent from in the third quarter ended 30 September, contrasting sharply with analyst predictions of 0.5 per cent growth.
The dollar jumped to a high of ¥117.06, which marked the beginning of a volatile day for the exchange rate.
Japan has now suffered two consecutive quarters of negative growth so is technically in recession but economists believe it will only be temporary.
“The immediate cause of… real GDP decline was inventories, meaning this is unlikely to be followed by another negative quarter,” said Charles Dumas, chairman of Lombard Street Research.
Inventories – the difference between production and sales – fell as firms reduced production in response to weaker domestic demand. The weak growth may also hinder Prime Minister Abe’s plans to hold a snap election so he can reshuffle the government.
“It would take an unusual electorate to reward the blunder of April’s consumption tax increase with a resounding endorsement,” Dumas said.
The poor data also adds pressure to Abe’s economic policies, labelled “Abenomics”. The “three arrows” of Abenomics involve fiscal spending, having the central bank create new reserves to buy assets from other banks, and structural reforms.