UPDATE 1-Japan raises budget cap due to welfare costs

* 2010/11 budget ceiling 2 percent higher than current year's

* Rising welfare costs lead to ceiling increase

* Budget ceiling could fan fears government to sell more debt

* Yosano: long-term yields biggest worry for fiscal policy

By Stanley White

TOKYO, June 30 (Reuters) - Japan's government has set a record 52.7 trillion yen ($550 billion) ceiling on budget spending for the fiscal year starting in April 2010, an increase from this year's main budget due mainly to rising social security costs, Finance Minister Kaoru Yosano said.

The limit on spending in the general account budget, which excludes debt servicing costs and tax grants to local governments, is up from the 51.7 trillion yen in spending in the main budget for 2009/10.

That could further strain Japan's fiscal condition, already the worst among major economies, by fanning fears that Japan will increase debt issuance to a new record.

"How long-term yields move is the biggest concern for fiscal policy," Yosano told reporters.

"Still, we have to allow for a natural increase in welfare spending in light of our ageing population."

Based on the ceiling, the Ministry of Finance will begin negotiations on budget requests from government agencies.

The MOF plans to earmark 350 billion yen in 2010/11 for spending to help families with children and improve the safety net for the labour force, Yosano said. That compares with a 300 billion yen quota set for 2009/10.

Japan will now allow for about a 1 trillion yen increase in pension and health care spending, Yosano said.

The government has already backtracked on a pledge to trim annual increases in welfare spending by 220 billion yen as ruling party lawmakers fretted the cuts could cost them votes in an election that polls show they are likely to lose. [ID:nT9404]

Yosano had said last week he would decide on the budget ceiling several weeks earlier than usual to avoid a clash with elections that must be held by October.

Legislators have already passed a record budget and the country's largest ever stimulus package. That brought total spending in the current year to March 2010, including that earmarked in an extra budget, to a record 102 trillion yen.

Japan's government plans to sell a record 44 trillion yen of new bonds in 2009/10 to finance this spending and analysts say falling tax revenues could nudge it into further increasing bond issuance. ($1=95.89 Yen) (Editing by Chris Gallagher)