UPDATE 2-Japan's Fujii: must keep trust of bond market

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

*10-year yields hit 2-1/2-mth highs on concern supply to rise

*Govt spending plans fuel concerns about fiscal discipline (Adds details on Japan Post in paragraph 7)

By Stanley White

TOKYO, Oct 28 (Reuters) - Japanese Finance Minister Hirohisa Fujii said on Wednesday it's important not to lose the trust of the bond market as there are concerns about rising bond yields and an increase in bond issuance.

Yields on benchmark 10-year Japanese government bonds reached a 2-1/2-month high on Wednesday as investors fret about the likelihood the government will sell a record amount of bonds after the Democratic Party-led government's budget requests for the fiscal year starting in April jumped to a record high.

Prime Minister Yukio Hatoyama told lawmakers in parliament that the government would do its utmost to limit bond issuance and maintain the trust of the bond markets.

But economists say this goal is in doubt as the Democrats haven't made enough spending cuts to offset the costs of their ambitious programmes to support the household sector.

"There are concerns in the markets," Fujii told a news conference.

"It is important that we keep these concerns and market moves in mind as we compile the budget."

Fujii also said that Japan Post, the national mail carrier that also has banking and insurance units, should lower its weighting in Japanese government bonds and lend funds to small- and medium-sized enterprises, but that such a shift would take time. Fujii also said the government shouldn't tap Japan Post as if it were a piggybank or a second budget.

Japan Post, which controls around 330 trillion yen in assets, has said a significant portion of its investments are in government bonds. The Democrats' plan to cancel the privatisation of Japan Post has raised concerns the government could reach a tacit agreement with the mail carrier to buy more bonds.

Fujii has already said the government could issue more bonds for the fiscal year to next March as tax revenues are likely to fall 6 trillion yen ($65.7 billion) or more below an initial estimate. He has also said he wants to limit bond issuance in 2010/11 to below the 44 trillion yen earmarked for this fiscal year.

Cabinet ministers submitted earlier this month a record 95 trillion yen in budget requests for 2010/11 as the Democrats piled on requests for payouts to households with children, for making high schools effectively free and for ending expressway tolls. The government is now trying to reduce the amount of budget requests. (Reporting by Stanley White; Editing by Hugh Lawson)