UPDATE 1-BOJ Yamaguchi warns Japan must get fiscal house in order

* JGB yields low but may suddenly spike -Yamaguchi

* Says Japan economy at standstill, outlook uncertain

By Leika Kihara

TAKAMATSU, Japan, Feb 2 (Reuters) - Japan must get its fiscal house in order now in case it loses market confidence in its finances in the future, the central bank's deputy governor said, warning that failure to do so could trigger a spike in bond yields and severely hurt the economy.

Deputy Governor Hirohide Yamaguchi also said the Bank of Japan will guide monetary policy mindful of strong uncertainty on Japan's economic outlook, such as the pain from a strong yen and slowing overseas growth, signalling the bank's readiness to ease further if the recovery is threatened.

The BOJ has repeatedly warned that Japanese bond yields may eventually spike unless the country acts promptly to slash its huge public debt which, at double the size of its economy is the biggest among advanced nations.

Bank of Tokyo-Mitsubishi, part of Japan's top banking group Mitsubishi UFJ Financial (MUFG), has a contingency plan to deal with a sharp decline in Japanese government bond prices, the Asahi newspaper reported on Thursday, underlining fears such a drop could be on the horizon.

Yamaguchi said it was "somewhat strange" that Japanese bond yields remained stable at low levels despite the country's massive debt burden, and cautioned that time was running out.

"When a country's borrowing continues to rise, as is the case now, we cannot rule out the risk of some trigger causing market confidence to suddenly be eroded," Yamaguchi said in a speech to business leaders in Takamatsu, southwest Japan, on Thursday.

"If that happens, the impact on the financial system and the economy will be huge, as seen in the case of Europe," he said, calling on the government to pursue fiscal reforms and take measures to bolster Japan's potential growth.

JGB yields have stayed low for more than a decade despite Japan's snowballling public debt, largely because the government has been able to tap domestic savings as Japanese investors shun risk assets such as shares. They have not been attracted much to foreign bonds as the yen keeps strengthening, with Japan running a current account surplus.

But many economists think that dynamic may change at some point in the coming years as Japan's current account balance could go into the red if companies keep moving factories abroad and income from foreign investments dwindles.

On Japan's economy, Yamaguchi repeated the central bank's view that growth has been more or less flat with many risks to its outlook including a slowdown in emerging economies, heightening tensions in Iran and Europe's debt crisis.

"We will continue to guide monetary policy appropriately, mindful of strong uncertainty over the near-term outlook such as the effect of the overseas slowdown and yen rises," he said.

Yamaguchi, one of the BOJ's two deputy governors, is a key figure to watch for signals on the future direction of policy and has voted with the board since assuming his current post in 2008.

The BOJ has been standing pat since easing monetary policy last October to ease the pain on the export-led economy from a strong yen and slowing overseas growth.

But it has expressed its readiness to offer further monetary stimulus if Japan's recovery prospects are threatened and has identified the fallout from Europe's sovereign debt crisis as the biggest risk to the outlook.