The boost expected from the government's 16 trillion yen economic stimulus package may be weakened if the downturn in employment and income continues to hurt overall economic activity, the Bank of Japan warned Tuesday.

In its monthly report on economic and financial developments, the central bank said the fiscal 1998 supplementary budget expected to be enacted today will boost domestic demand through extra public works spending and special income and resident tax cuts.

The stimuli are expected to break the downward cycle currently affecting production, income and spending, the report says. "However, such positive effects of fiscal policy may be weakened if the ongoing rapid deterioration in employment and income conditions further dampen overall economic activities," the report says.

Authorities must continue monitoring economic developments, including trends in corporate and household confidence, it says, indicating the BOJ is concerned about the effects of reports showing record unemployment and lowered consumption.

The report says downward pressure on domestic prices induced by the fall in import prices has already weakened, and the pump-priming measures will help slow the expansion of the gap between supply and demand in the economy.

But given the relatively large output gap and high inventory levels, prices are likely to remain weak for some time, and could fall further if domestic demand fails to pick up, the report says.

The central bank report also notes that smaller businesses are still having trouble financing their operations due to a lack of available funding and high fundraising costs.