* Government warns Japan's recovery weakening
* Territorial spat between Japan and China may hit sales
* Business mood worsens, especially among manufacturers
(Adds economics minister's quotes)
By Kaori Kaneko and Leika Kihara
TOKYO, Oct 12 (Reuters) - Japan's government downgraded itsview of the economy for the third straight month in October asworries about Europe's debt crisis and China's slowdownintensified, adding pressure on the central bank to offerfurther stimulus to support growth.
It was the longest streak of downgrades since five straightmonths of cuts made just after the collapse of Lehman Brothersin 2008, underscoring Tokyo's growing alarm that the prolongedoverseas slowdown may again nudge Japan into recession.
Economics Minister Seiji Maehara said that while it was tooearly to judge whether Japan may slip into recession, theeconomy's trend was weak as weak global demand hurt exports.
"A further slowdown in global growth and volatility infinancial markets may hurt Japan's economy, which are risks wemust be vigilant to," Maehara told a news conference on Friday.
The downgrade in assessment followed the Bank of Japan'swarning last week that economic activity was levelling off andmay not recover until well into next year.
"The economic recovery has had a weak tone recently due to aslowdown in the global economy, although some steadiness isstill seen," the government said in its latest monthly reportreleased on Friday.
Slackening overseas demand and weak exports also promptedthe government to lower its assessment on factory output andcorporate sentiment.
PRESSURE ON BOJ
Japan's economy has so far outperformed most of its peers inthe Group of Seven helped by spending on reconstruction fromlast year's earthquake and tsunami. But weak external demand anda strong yen have led analysts to project growth will likelystall for the rest of this year.
The International Monetary Fund also trimmed its growthforecasts for Japan, as factory output fell to a 15-month low inAugust on sagging sales to top export market China and businesssentiment worsened in the three months to September.
Adding to headaches for policymakers is the impact of aterritorial dispute with China, which has sparked anti-Japanprotests in China and calls for boycotts of Japanese goods.
"Trouble stemming from the (territorial dispute) isaffecting businesses including the auto sector, which would alsoimpact other related industries such as materials and iron andsteel," said Minoru Masujima, director of macroeconomic analysisat the Cabinet Office, which is charged with compiling themonthly report.
The government's bleak assessment adds pressure on the Bankof Japan for action ahead of its rate review on Oct. 30.
At the meeting, the central bank is set to cut its long-termgrowth forecasts and admit that it will take take several moreyears for Japan to achieve its 1 percent inflation target, andbring to an end a long-running deflationary era.
The economics minister, a vocal advocate of more aggressivemonetary easing, kept up calls for further BOJ action, sayingthat the central bank has a responsibility to achieve its pricetarget at an early date.
"We will continue to call for powerful monetary easing bythe BOJ," Maehara said.
(Editing by Simon Cameron-Moore)
Keywords: JAPAN ECONOMY/REPORT