Japan?s jobless rate dropped to its lowest level in two-and-a-half years in December, pointing to improved business conditions and the possibility of an upturn in consumer confidence.

Unemployment fell to 4.9 per cent from 5.2 per cent, having started last year at a record high of 5.5 per cent, the government said Friday. The average for 2003 was 5.3 per cent, 0.1 percentage point down on the previous year - the first annual improvement in 13 years.

The sharp December drop, which had not been predicted by economists, reflected falling bankruptcies, a slowdown in restructuring and a return to business expansion in certain sectors.

It boosted expectations that Japan?s export-driven recovery could kickstart a cycle of higher incomes and stronger household spending. These factors have been missing from a two-year economic upturn so far led by industry.

The economy added 170,000 new jobs in December, helping lift the ratio of jobs to applicants to 0.78 from 0.74, its highest level since 1993. ?The improvement has been surprisingly rapid, especially in terms of the new job offers out there,? said Richard Jerram, economist at ING in Tokyo. ?It tells us business conditions have changed substantially, almost as if somebody flicked a switch.?

Mamoru Yamazaki, economist at Barclays Capital in Tokyo, said in a research note: ?The sharpest growth in worker numbers came in medical care and welfare, and restaurants and lodging, suggesting the manufacturing-centered expansion is starting to impact on domestic expansion.? The improvement is not universal, with youth unemployment rising as companies retain existing workers but scale back graduate recruitment. One executive said his company would never sack the employees, now in their 50s, who had helped create Japan?s economic miracle. Instead, it had cut back drastically on hiring new recruits. The jobless rate for men aged 24 or younger rose by 0.5 percentage points in 2003 to a record 11.6 per cent, although this too fell sharply in December to 10 per cent. Even this disguises a gradual change in youth labour, with more people in their 20s taking low-paid, casual jobs with little security or fringe benefits.

Kiichi Murashima, economist at Nikko Citigroup, said unemployment was unlikely to continue falling in large increments. ?We will continue to see stabilisation in the labour market but not outright improvement, due to a mismatch between supply and demand.? In particular, there was a shortage of younger people with IT skills, he said.