Japanese prime minister Yukio Hatoyama said he has not given up on capping new bond issuance next fiscal year at the government's target of 44 trillion yen (€338 billion) but acknowledged it would be hard to meet, casting doubt on the course of fiscal policy.
Prices of longer-dated bonds fell, pushing up yields, as investors took a flurry of conflicting comments on next fiscal year's budget as a sign the government is losing its grip on fiscal discipline.
The budget debate coincides with concerns about Mr Hatoyama's leadership that are eroding his support rates ahead of an upper house election next year, in which his Democratic Party aims to win an outright majority so it no longer needs to rely on two tiny but vocal coalition partners to pass bills smoothly.
A newspaper poll published on Monday showed voter support for his government slipping to 59 per cent, still high for a Japanese leader but off initial highs of over 70 per cent.
"Most investors don't expect the government to stick with this bond issuance target," said Hideaki Kinoshita, chief manager of proprietary trading at Bank of Tokyo-Mitsubishi UFJ.
"But the pace of bond issuance will eventually break the market's back. Rates are sure to rise. It's just a question of when."
Mr Hatoyama said today the government needs to maintain fiscal discipline and limit Japanese government bond issuance to 44 trillion yen.
"Fiscal discipline is important to some extent and I think we need to keep this. The 44 trillion yen has become a symbolic figure and we cannot give up this cap easily," Mr Hatoyama told reporters.
"But the mission of politicians and the government is to protect the lives of the people and there is the issue of how to decide on that. We are not saying that the cap cannot be exceeded even by one yen."
Finance minister Hirohisa Fujii said sticking to the 44 trillion yen cap would not erode people's quality of life.
He said the government will cut 690 billion yen of spending from ministries' budget requests totalling 95 trillion yen.
The benchmark 10-year JGB yield rose 2 basis points to 1.260 per cent. Longer-end bonds were generally weaker, with the 20-year yield rising 2 basis points to 2.035 per cent.
Chief cabinet secretary Hirofumi Hirano said Hatoyama wants to spell out a bond issuance cap in a budget outline the cabinet plans to announce next week.
Japan's government, in power for three months, must balance campaign promises to put more money in the hands of consumers and pressure from coalition partners to spend more against the spectre of falling tax revenues and a bulging public debt already headed for 200 per cent of GDP next year.
Mr Fujii said the government may have to scale back spending on some of the policies it promised in its election campaign.
"Ruling parties need to take a mature response, when economic conditions have changed," he told a news conference.