Japanese cabinet ministers on Tuesday moved to shore up confidence in U.S. debt after Standard & Poor's threatened to lower its credit rating on the world's largest economy due to a bulging budget deficit, touching a nerve with one of the largest holders of Treasuries.

S&P, which assigns ratings to guide investors on the risks involved in buying debt instruments, slapped a negative outlook on the United States' top-notch AAA credit rating on Monday and said there was at least a one-in-three chance that it could eventually cut it.

Japan is the second-largest holder of Treasuries after China and its confidence in dollar-denominated assets has been steadfast until now, but the prospect of a ratings downgrade could test Japan's faith in Treasuries.

The increasing chance of a downgrade for the United States could also draw unwanted attention to Japan's large debt burden, which is likely to grow larger as the government secures funding to rebuild after last month's devastating earthquake and tsunami.

The United States is tackling fiscal issues in various ways, so I still think U.S. Treasuries are basically an attractive product for us, Finance Minister Yoshihiko Noda told reporters after a cabinet meeting.

If investors start demanding higher returns for holding riskier U.S. debt, the rise in bond yields could erode the value of Treasuries held in currency reserves and push borrowing costs up in other countries.

Japan's reserves rose to $1.12 trillion at the end of March from $1.09 trillion at the end of February after Japan and other Group of Seven countries intervened to stem a rise in the yen.

The bulk of Japan's reserves are believed to be held in Treasuries.

Even if a private company downgraded, U.S. treasury bills are in demand from the world, Economics Minister Kaoru Yosano said.

Japan's public finances are also in a dangerous state, and the timing of S&P's warning could be a source of discomfort.

Japan is set to compile an extra budget worth about 4 trillion yen ($48.4 billion) to start reconstruction after the March 11 earthquake and tsunami, which also triggered the world's worst nuclear crisis in a quarter century.

This is likely to be the first of several spending packages. Japan's public debt is already twice the size of its $5 trillion economy, and policymakers have said new bond issuance would be needed after the first extra budget to pay for reconstruction costs.

S&P cut Japan's sovereign rating to AA-minus in January, although it said shortly after the March disaster that it did not expect to change its ratings stance on Japan.

($1 = 82.675 Japanese Yen)

(Editing by Edmund Klamann)