* Japan plans massive public and private investment through

fiscal 2040

* Benchmark yields rise to highest since September 1996

* Recent 10-year JGB auction drew lower demand despite

elevated yields

By Junko Fujita

TOKYO, July 9 (Reuters) - Japan's bond market is signalling

diminishing confidence that the central bank can contain

inflation while the government's spending ambitions further

strain the nation's finances.

Yields on 10- and 20-year Japanese government bonds (JGBs)

shot to multi-decade highs this week as concerns resurfaced

about Prime Minister Sanae Takaichi's commitment to fiscal

responsibility and normalisation of monetary policy.

The gap between 10-year and 2-year JGB yields widened on

Wednesday to 143 basis points (bp), the highest since 2004, and

reflecting growing concerns about inflation and price risk on

the long end along with shrinking expectations for rate hikes by

the Bank of Japan on the short end.

"The latest steepening of the curve is a warning bell from

investors," said Kento Minami, senior economist at Daiwa

Securities. "There is a gap between the risk the market weighs

and the government's fiscal and monetary policy."

UNFUNDED TAX CUTS

The widening rate gap comes with growing unease that the

government's economic blueprint, unveiled last month, could

constrain the BOJ's ability to tighten monetary policy. Tokyo is

now reportedly considering revising the document's language in a

bid to calm the bond selloff.

The blueprint reinforced impressions that The Takaichi

administration views accommodative monetary policy as a

prerequisite for successful public-private growth investment,

and would thus be "unlikely to look favourably" upon rationales

for rate hikes, Mizuho Securities analysts said in a note.

The BOJ raised its short-term policy rate to 1% in mid-June.

Swap rates indicate an 87% chance of another 25 bps

increase at the bank's policy meeting in December, according to

LSEG.

The 10-year JGB yield climbed further on

Thursday, reaching 2.88%, the highest since September 1996 and

marking its ninth straight day of gains, the longest streak in

19 years.

The yield's 20.5 bp jump this month compares to just 8.5 bp

for the two-year JGB, the one most sensitive to BOJ policy.

"This is a reflection of market concerns that the BOJ will

not be able to raise rates faster," said Katsutoshi Inadome,

senior strategist at Sumitomo Mitsui Trust Asset Management.

The latest bout of selling echoes a pattern set in motion

since Takaichi took office last year. Her aggressive spending

plans sent 30- and 40-year bond yields to successive highs in

May, but they subsided after the finance ministry trimmed

super-long debt issuance.

Those worries have now resurfaced. Japan has disclosed plans

to spend more than 370 trillion yen ($2.28 trillion) in combined

public and private investment through fiscal 2040, alongside an

unresolved debate over cutting the tax on food to 1% without

specifying how it would be funded.

Yields at multi-decade highs have yet to entice buyers back

into the market. A sale of 10-year JGBs last week saw measures

of demand fall to the lowest since April.

"There are multiple reasons that the 10-year bond yields are

not going to fall," said Masayuki Koguchi, executive chief fund

manager at Mitsubishi UFJ Asset Management.

"The 10-year bond yield is low relative to the nation's

inflation. And as prices are set to rise further, the yield

would have to rise."

The Takaichi administration has tried to assuage markets

with reassurances that new spending will be responsible, paid

for by rising tax receipts and government efficiencies rather

than new debt issuance. She contends that faster economic growth

will bring down Japan's debt-to-GDP ratio, the highest in the

developed world at more than 200%.

"Given that Japan is now experiencing inflation, it is

important for Japan to run fiscal and monetary policy that

corresponds with the real economy," said Daiwa's Minami.

($1 = 162.3900 yen)