Japan's business activity shrank in March for the first time in five months, with manufacturing output declining at the fastest pace in a year, according to flash data from au Jibun Bank.

The composite PMI fell to 48.5 from 52.0 in February, slipping below the 50 threshold that separates growth from contraction.

Manufacturing output dropped to 46.5 from 48.4, marking the ninth straight month of contraction. Service sector activity also softened, with the business activity index falling to 49.5 from 53.7, reflecting weaker demand as inflation pressures weighed on customer spending.

Cost pressures remained high, with input costs rising sharply, especially in services, where inflation reached a 25-month high.

Despite the slowdown, employment increased modestly as firms pursued expansion plans.

Persistent inflationary pressures have added to the strain on businesses. Japan's core consumer prices, excluding fresh food, rose by 3% year-on-year in February, remaining above the Bank of Japan's (BOJ) 2% target.

This has reinforced market expectations of potential interest rate hikes.

The BOJ maintained its key short-term interest rate at 0.5% during its March meeting, but speculation about gradual increases remains.