It said in a monthly report that the pace of decline in consumer prices has eased but Japan remains in mild deflation, a slight change from the previous report when it just said the economy was in mild deflation.

"The economy is still picking up slowly, while difficulties continue to prevail due to the earthquake," the Cabinet Office said in the report for April, the sixth straight month it has used the same expression.

The government's view is similar to that of the Bank of Japan, which said on Tuesday the economy is showing signs of picking up, while its Governor Masaaki Shirakawa offered an upbeat view on the outlook.

The government said the nation's exports are "leveling off", upgrading its view for the first time since August. It previously said exports were weakening.

Japan posted its first trade surplus in five months in February after shipments to the United States rose at their fastest annual pace in more than a year.

"The moderate recovery in the U.S. economy had a positive effect on Japan's economy, with some recovery in Japan's shipments to Asia. And falls in exports to Europe seem to be halting," said Minoru Masujima, director of macroeconomic analysis at the Cabinet Office.

"But it is not a situation where exports will rise rapidly or in which the overseas economic recovery is gathering steam, and impact on Japan's economy."

With little or no rise in Japan's core consumer prices, the government expects mild deflationary pressure to continue, and sees achieving the Bank of Japan's 1 percent consumer inflation target as some way off.

The BOJ will consider easing monetary policy at its next rate review on April 27 by boosting government bond purchases under its asset-buying program, sources familiar with the central bank's thinking said, as it battles to nudge inflation towards its target.

Consumer spending is holding firm partly due to government subsidies for fuel-efficient cars, and industrial output is picking up moderately, the report said.

"Domestic demand is relatively solid but not strong and factory output is continuing a slow pickup. We would like to assess more data on whether to upgrade the assessment on the economy."

Japan's economic recovery is expected to take hold in the coming months but there are risks from Europe's debt crisis, higher oil prices and concerns about the electricity supply, it said.

Prime Minister Yoshihiko Noda's administration is being buffeted by conflicting pressures over energy policy, with big businesses urging it to get nuclear reactors back on line and keep atomic power in the energy mix to keep the economy afloat, while many voters worry about safety after the Fukushima radiation crisis triggered by last year's disaster.

All but one of the nation's 54 reactors are offline due to public safety fears, mostly idled as they came due for maintenance.

The government is keen to get some reactors restarted soon to avoid power cuts in the summer, when electricity demand peaks, but none of the reactors can be restarted until they clear safety reviews and receive approval from local governments.

The government also remains vigilant for fluctuations in financial markets, with the yen having strengthened from last month's 11 month-low of 84.187 yen.

The dollar fetched 80.91 yen on Thursday, while the euro was around 106.15.

"Resurgence in the yen's strength and falls in share prices could negatively affect the economy through business and consumer sentiment, if such trends accelerate," another official said.

Finance Minister Jun Azumi said on Wednesday he was watching forex moves with great interest and Japan would respond to currency moves by examining market trends.

The economy is expected to expand 1.9 percent in the fiscal year that started on April 1 as post-quake rebuilding in the northeast gathers steam.

(Editing by Kim Coghill and Michael Watson)

• A Permanent Economic Emergency