By Tamiyuki Kihara and Leika Kihara
TOKYO, May 18 (Reuters) - Japan's government will likely issue fresh debt as part of funding for a planned extra budget to cushion the economic blow from the Middle East war, a government source with direct knowledge of the deliberation told Reuters on Monday.
Any additional debt issuance would further strain Japan's already worsening finances and may accelerate rises in long-term interest rates.
Concerns over worsening government finances pushed the benchmark 10-year
Japanese government bond (JGB) yield to 2.8% on Monday, the highest since October 1996, and the 30-year yield to a record top.
Prime Minister Sanae Takaichi is planning to instruct the government to consider formulating a supplementary budget on Monday although the size of such a package was yet to be decided, the source said.
Sources told Reuters last week the government was looking to compile a supplementary budget to ease household energy costs.
In a proposal to the Ministry of Finance, opposition party leader Yuichiro Tamaki on Friday called for an extra budget of around 3 trillion yen ($18.9 billion) - which may serve a benchmark for future debate on the size of spending.
The extra budget will focus on funding government subsidies to curb gasoline and utility bills, as surging oil prices caused by the Middle East conflict cloud the outlook for an economy heavily reliant on fuel imports from the region.
"When countries like Japan and Britain contemplate fiscal stimulus, there's a tendency for that to trigger a triple selling of shares, currencies, and bonds because their economic growth is weak and inflationary risks are high," said Daisuke Uno, chief strategist at Sumitomo Mitsui Banking.
The bond selloff would also complicate the BOJ's decision on whether to raise its short-term policy rate to 1% from 0.75% at its next meeting in June.
At the June meeting, the BOJ will also conduct a review of its existing bond taper plan and announce a new plan for fiscal 2027 onward.
The war-induced spike in energy prices, coupled with rising import costs from the weak yen, pushed Japan's wholesale inflation to a 3-year high of 4.9% in April, bolstering the case for the central bank to raise rates as soon as next month.
"If inflationary risks heighten, there's a chance the BOJ could raise short-term rates to 1.5% by the March end of the current fiscal year," said Mari Iwashita, executive rates strategist at Nomura Securities, adding that the 10-year yield could head towards 3%.
($1 = 158.8900 yen)
(Reporting by Tamiyuki Kihara and Leika Kihara, additional reporting by Mariko Sakaguchi and Anton Bridge; Editing by Shri Navaratnam and Sam Holmes)
