The 8.1 percent annual fall was far deeper than economists' median forecast of a 2.9 percent drop. A 25.1 percent plunge in exports to the struggling European Union, the biggest such drop since Oct 2009, saw Japan post a record trade deficit with the region.

"Europe's debt crisis is the first factor to pull down exports, and the pace of decline is striking. This is comparable to the post-Lehman situation," said Masayuki Kichikawa, chief Japan economist at Bank Of America Merrill Lynch in Tokyo.

"We hoped domestic demand in China would support Japan's economy, but the story is different."

Wednesday's figures add to the case that the bottom of the slowdown in economic growth for Asia's major exporters could well be pushed further back into the third quarter of 2012 from the second quarter.

"That's the way risks are tilting," said Robert Prior-Wandesforde, director of Asian economics at Credit Suisse in Singapore. "It's hard to be optimistic given what's happening in key trading partners."

Exports from Taiwan, a key part of the global technology supply chain, fell for a fifth straight month in July. South Korea, home to major carmakers, computer chip and flat-screen producers, recorded its sharpest fall in exports in July in nearly three years.

China's exports rose just 1 percent in July, undershooting expectations by a big margin.

"We are becoming increasingly concerned," Prior-Wandesforde said. "Across the board, exports are weaker and have generally disappointed expectations."

The slump in EU imports of Japanese goods underpinned expectations that the trading bloc has slipped into a recession.

Exports to China, Japan's largest trading partner, fell 11.9 percent from a year earlier, the biggest decline in five months, led by lower shipments of semiconductors, electronics and car parts.

That gels with China data that has shown economic growth struggling to pick up after six straight quarters of decline despite two rate cuts and reductions in banks' required reserves.

In another discouraging sign, Japan's exports growth to the United States slowed in July for the third consecutive month, rising 4.7 percent from a year earlier.

Reflecting the sharp decline in overall exports, the Ministry of Finance figures showed Japan swung to a larger-than-expected deficit of 517.4 billion yen ($6.5 billion).

Analysts said the data heightened the risk that overseas demand for Japanese goods may not recover in time to take up the slack from domestic spending as the reconstruction impact after last year's earthquake begins to fade.

That could stall what is an otherwise fragile recovery in the world's third-biggest economy.

The strength of the yen also hurts Japanese exporters. Carmaker Nissan Motor Corp (7201.T) said the yen's rise had reduced its April-June operating profit of 120.7 billion yen by 25.7 billion yen.

Stock traders said the Japanese data weighed on sentiment in Asian markets on Wednesday as it provided a reminder of the risks the euro area posed to Asia's economies.

MSCI's index of Asia Pacific shares outside of Japan fell 0.7 percent. In Japan, exporters Canon Inc (7751.T) and Sony Corp (6758.T) underperformed the Tokyo market, falling 1 percent each. The Nikkei average .N225 edged 0.3 percent lower.

OUTLOOK GRIM

Data from South Korea and Taiwan suggested little relief for Asia.

In the first 20 days of August, South Korea's exports fell 12.4 percent from a year earlier, leaving a $4.5 billion trade deficit for the period.

Orders for Taiwan's exports, a forward indicator of demand, slumped 4.4 percent in July over the previous year, far more than expected.

Despite the disappointing numbers all round, barring a larger shock in Europe than currently factored in, Asian policymakers are unlikely to take any aggressive policy steps to counter the exports slowdown, said Nigel Chalk, managing director of research for emerging Asia at Barclays.

"If it's a muddling through a relatively low-growth scenario, then I don't think you'll see anything big," he said. "They'll just try to hunker down and push up domestic demand as much as they can. The underlying growth story isn't terrible. Things are slowing but it's certainly not recession in most of the region."

Despite the slump in exports, the outlook for Japan's economy is not as bad as it is for other industrialized countries, economists say.

The euro zone barely skirted recession in the first half of 2012 and is expected to slip into it in the second half.

Analysts have lowered their expectations for the U.S. economy in Reuters latest poll.

They have also cut their expectations for Japan's growth in the second half of calendar 2012, but they still forecast it will outpace most other G7 countries.

The Bank of Japan has become less convinced about its recovery scenario, but it hopes to stand pat on monetary policy for as long as possible to save its limited further options, after having expanded monetary stimulus in February and April.

(Additional reporting by John O'Callaghan and Charmian Kok in Singapore; Writing by Tomasz Janowski; Editing by John Mair and Neil Fullick)

• A Permanent Economic Emergency