UPDATE 2-Japan govt aims to offset spending freeze with jobs

(For more stories on the Japanese economy, click [ID:nECONJP])

* Democrats redirecting spending they consider wasteful

* Some worry spending shift bad for economy in short term

* Yield curve near steepest in 3-½ years on supply woes (Recasts, adds details)

By Stanley White

TOKYO, Nov 6 (Reuters) - Japan's government aims to offset the negative impact of freezing part of an extra budget compiled by the previous administration by taking steps to help create jobs, National Strategy Minister Naoto Kan said on Friday.

The Democratic Party-led government is facing a difficult balancing act as it tries to rejig a budget created by the ousted Liberal Democratic Party and compile one for 2010/11 that will free up funds for its programmes without harming the fragile economic recovery and causing bond issuance to spiral out of control.

"We decided to freeze 2.9 trillion yen, but only around 900 billion yen of that spending was allocated for the current fiscal year," Kan, who is also deputy prime minister, told reporters after a cabinet meeting.

"The measures for the labour market that we are considering now are likely to cancel out the negative impact."

Kan said freezing 2.9 trillion yen ($32 billion) in spending from the extra budget could lower gross domestic product by 0.2 percentage point in the year to March 2010.

He added that the government's plan to compile emergency employment measures could create around 100,000 new jobs, which could offset the negative effect on GDP.

Kan has said the jobs scheme won't require new funding as the government can use existing programmes. But Kan is also calling for the Democrats to pull together yet another extra budget, likely to be submitted to parliament next year, that will include measures for the environment.

The government hasn't decided exactly what will go into that budget and how they'll pay for it. Investors have already concluded that extra bond issuance is all but avoidable.

Demand was weak at an auction of benchmark 10-year government debt JP10YTN=JBTC on Thursday, and the yields on the notes hit a three-month high of 1.455 percent on Friday.

"If 10-year yields hit 1.5 percent, that would be an attractive level for life insurers to buy, so it is possible for long-term yields to pull back later this month," said Tetsu Aikawa, deputy general manager of the capital markets division at Shinsei Bank.

"Still, concerns about extra bond issuance and the government's spending plans aren't likely to fade anytime soon."