UPDATE 1-Japan may turn to Yamaguchi to head BOJ - media
(Adds market, opposition comments) (For more on the search for a new BOJ head, click [ID:nT55777])
TOKYO, March 2 (Reuters) - Japan's government may be forced by opposition lawmakers to change its candidate to head the central bank, with former Deputy Governor Yutaka Yamaguchi a possible alternative, Japanese media reported on Sunday.
The government's favoured candidate, current Bank of Japan Deputy Governor Toshiro Muto, was still the frontrunner to replace Governor Toshihiko Fukui when he retires in just over two weeks, the Yomiuri newspaper said, but a parliamentary row on Friday has threatened his candidacy.
Muto is the firm favourite of financial markets, polls show, and a sudden change to another candidate would surprise them, although Yamaguchi was a Bank of Japan official for many years.
"Monetary authorities and business lobbies are recommending Muto. It's natural for him to become governor," Bunmei Ibuki, the secretary general of ruling Liberal Democratic Party, was quoted as saying by the Asahi newspaper.
Muto was widely seen as a clear favourite until Friday when the opposition, already uneasy with the idea of a former senior finance ministry official such as Muto running the central bank, was angered when the government passed its annual budget through parliament's lower house despite a plea for more debate.
The main opposition party, the Democrats, declared that cooperation with the government had ended, and Japanese media reported that the party would reject nomination of Muto.
CRITICISED IN PAST
Yamaguchi, a career central banker who served as deputy BOJ governor from 1998 until he retired in 2003, is known for his extensive knowledge of economic theories.
But central bank watchers also say the 67-year-old may lack Muto's skills in political manoeuvring.
He was criticised, along with then BOJ chief Masaru Hayami, for raising Japanese interest rates from zero in August 2000 -- a move the government blamed for an subsequent economic slump.
"I do not get the sense that the overall direction of monetary policy will change even if Yamaguchi were to become the BOJ Governor," said Masafumi Yamamoto, head of FX strategy Japan, for Royal Bank of Scotland.
"Japanese data and monetary policy are not really focal points of financial markets at this point, so I do not think there will be much of a reaction."
Yamamoto said Yamaguchi had been touted as a candidate for BOJ Governor in the past was well-respected internationally.
Opposition control of parliament's upper house gives the Democrats and their allies the power to veto key appointments such as central bank governor.
Japanese interest rates have been low for years, as it struggled to recover from a burst bubble in 1990, and currently sit at just 0.5 percent.
The central bank wants to raise rates to more normal levels to avoid economic overheating, but it has been stymied by market turmoil in the wake of the U.S. subprime crisis.
Japanese media reported on Sunday that the government had been angered that the opposition had allowed politics to intrude into monetary policy, but they also reported that other candidates could not be ruled out.
The government has said it is unwilling to risk a policy vacuum at the central bank as the world faces a slowdown and a possible U.S. recession.
It is seen putting forward candidates for governor and two deputies some time this week, to allow 10 days for parliament's two houses to consider the appointments.
Many Democrat lawmakers have said Muto is unsuitable to lead the central bank because as a former vice finance minister he is too close to the government. They argue for a complete separation of monetary and fiscal policy.
While angered by the budget move on Friday, the Democrats may soften their stance after cooling off, the Yomiuri said.
But it also reported that a senior Democratic lawmaker had said the party would endorse Yamaguchi, if he was nominated.
Democratic Party executive Kenji Yamaoka said on television the conflict over the budget ought to be kept separate from the BOJ succession, but he added: "The same people are doing these so although we intend to do this properly, as the people want, we are not in a situation where if they say 'how about this' we will just smile and say yes." (Additional reporting by Masayuki Kitano and Linda Sieg; Writing by Rodney Joyce; Editing by Jan Dahinten)
