Improved business spending and better prospects for exporters prompted the Japanese government to raise its official reading on the economy for the second straight month, though officials stopped short of saying a full recovery was under way.
"The economy is showing signs it is headed for a recovery," the Cabinet Office said in a monthly report, a shift in the all-important wording from the August report's verdict that economic conditions were flat.
The upgrade follows a string of data suggesting Japan's economy is perking up after a decade of stagnation.
Revised gross domestic product data released last week showed the economy grew at its fastest clip in two-and-a-half years in the April-June quarter - an annualised 3.9 per cent, compared with US growth of 3.1 per cent for the same period.
However, ministers and officials stopped short of declaring the pick-up a full-blown recovery, noting that deflation was maintaining its grip on the economy and that conditions for smaller firms and non-manufacturers were still severe.
The Bank of Japan acknowledged that conditions were still precarious by maintaining its super-loose monetary policy in a two-day policy board meeting that ended on Friday.
"There are some good signs for the economy, but it has not reached the point of a self-sustaining recovery," Bank of Japan Governor Toshihiko Fukui said after the meeting.
Nevertheless, business spending is rising, while corporate profits continue to improve, the Cabinet Office report noted.
Relatively strong machinery orders data and improved business sentiment surveys have confirmed a view that corporate investment is on the rise, while stock prices are some 45 per cent above 20-year lows touched earlier this year.
Exports are also recovering, helped by Asia-bound shipments as worries over Sars receded, the report said.
Expectations for faster growth in the US economy suggest export demand could quicken, it said.
Adding to the good news on Friday was a decline in corporate bankruptcies in August for the eighth straight month.
All of this was good news for Prime Minister Junichiro Koizumi ahead of a vote on his party leadership - and so his prime ministership - next weekend.
"As is reflected in this report, the economy is on its way to breaking out of a state in which conditions were flat," Economics and Financial Services Minister Heizo Takenaka told reporters.
The report cautioned, however, that both production and consumer spending conditions remained flat.
Jun Saito, director of economic assessment and policy analysis at the Cabinet Office, told reporters an unusually cool and wet summer did not have a big impact on the economy.
But he said sluggish sales of items such as air conditioners and beer had bloated inventories and held back production.
Some economists had expressed concern that the weather could slow down the economy in the current quarter. In a nod toward concerns that recent rises in long term interest rates could hurt companies and the heavily indebted government, the BOJ said it would consider extending the duration of repurchase operations for government securities.
"We are trying to reassure the markets," Mr Fukui said. Short-dated Japanese government bond prices rose after the BOJ announcement, pushing yields down.
The yield on the benchmark 10-year bond closed at 1.52 per cent, up four basis points from Thursday, after easing to 1.48 per cent after the BOJ announcement.
The Cabinet Office's Saito also said recent strength in the yen warranted concern, but it was not a factor that changed the government's overall outlook on growth.
Japanese authorities are believed to have intervened in the foreign exchange market in recent weeks to curb the yen's strength, which officials worry could hurt exports.