The 0.1 percent decline in factory output was less than a median market forecast for a 0.4 percent decline and follows a 1.0 percent decrease in November, government data showed on Thursday.
Manufacturers surveyed by the Ministry of Economy, Trade and Industry expect output to fall 0.1 percent in January and grow 2.6 percent in February, the data showed on Thursday.
Economists see factory activity remaining fragile and possibly deteriorating further as a slowdown in overseas economies challenges Japan's export-reliant economy.
Japanese policymakers worry about ripple effects on the economy from the trade war between the United States and China — key markets for Japanese goods such as cars and electronics — undermining years of their efforts to foster sustainable growth.
Businesses are under pressure to safeguard margins and profits, with exports in December falling the most in two years due to plunging shipments to China, as the Sino-U.S. trade war weighs on global factory activity.
The United States and China opened a pivotal round of high-level talks on Wednesday aimed at bridging deep differences over China's intellectual property and technology transfer practices and easing a months-long tariff war.
Bank of Japan Governor Haruhiko Kuroda warned of growing risks to the economy from trade protectionism and faltering global demand last week as the central bank cut its inflation forecasts and stuck to its stimulus program.
The International Monetary Fund (IMF) trimmed its global growth forecasts and a survey this month showed pessimism increasing among business chiefs amid the trade tensions.
The trade ministry maintained its assessment on factory output, describing it as being in a "gradual pick-up."
Japan's economy, the world's third largest, is expected to rebound from the third quarter contraction caused by natural disasters, but many economists see the external headwinds weighing on any recovery from accelerating.