Japan's Finance Minister Naoto Kan reiterated his desire to target inflation, setting up a clash with the Bank of Japan over how best to pull the country out of deflation.

Kan, speaking in an interview with the Yomiuri newspaper published on Monday, said that a 1 percent rise in prices was desirable and that the central bank basically held the same view.

He also told parliament on Monday that while the government will take steps to boost domestic demand, he wanted the BOJ to do its part to overcome persistent price falls.

It would be more difficult to restore Japan's finances without beating deflation, Kan told a lower house budget committee.

I hope the BOJ will strive to pull Japan out of deflation, in sync with (government efforts).

The government fears deflation and a strong yen could hurt Japan's fragile recovery ahead of elections in the summer, but it is limited in what it can do by the country's massive public debt.

As one way to finance its spending, the finance minister also told the Yomiuri paper he would consider devoting sales tax revenue to welfare costs, suggesting a sales tax hike may be possible in future as Japan's aging society means health costs are likely to grow.

But ratings agency Standard and Poor's downplayed the benefit of any such hike if done too early in Japan's economic recovery.

While the government and central bank may agree on an ideal level of inflation, they remain apart over how to achieve it.

Bank of Japan Governor Masaaki Shirakawa last week rejected the idea of inflation targeting, saying that tying monetary policy to short-term price moves wouldn't work.

Like other central banks around the world, the BOJ has started unwinding some of the measures it introduced in response to the global financial crisis. But it has kept interest rates near zero.

With prices likely to continue slipping due to weak demand and with economic growth to remain slow for some time, the BOJ may come under fire from the government again to ease monetary policy more.

While Kan's call for 1 percent inflation is in line with the BOJ's understanding of price stability, the mere mention of such a goal effectively raises the pressure on the central bank.

There are many ways to go about achieving such goals, the Yomiuri quoted Kan as saying, citing an interview held on Sunday.

Prime Minister Yukio Hatoyama told the same parliamentary committee on Monday that he wanted the BOJ to help support the economy.

The government will undoubtedly do all it can. I also hope the BOJ will conduct monetary policy appropriately, he said.

The central bank yielded to a barrage of government criticism in December by calling an emergency meeting and announcing it was pumping more cash into the banking system.

The BOJ has maintained its commitment to keep monetary conditions very easy, but with interest rates at 0.1 percent, it has few conventional policy options left.

HUGE DEBT LIMITS GOVT

S&P said last month it would cut Japan's rating unless the government, which has been in office for six months, produced a credible plan to rein in debt and lift growth.

Still, there is relatively little chance S&P will downgrade Japan's sovereign rating this year unless there is a major economic shock, analyst Takahira Ogawa said on Monday in Dealing Room, a Reuters Messaging chatroom.

Concern that bond issuance will spiral out of control as the government shifts spending to measures supporting households has pushed the cost of buying protection against sovereign debt default to a 10-month high this month.

The International Monetary Fund says Japan's public debt could hit 227 percent of GDP in 2010 -- greater than the combined annual economic output of Germany, France, Britain and Canada.

But Hatoyama has repeatedly said he doesn't want to raise the sales tax from the current 5 percent until the next general election, which must be held by late 2013.

The government has said it will come up with a long-term fiscal plan by June, but it unsettled financial markets last year by drafting a record 92.3 trillion yen ($1,009 billion) budget for the fiscal year from April.

(Additional reporting by Tetsushi Kajimoto; Editing by Hugh Lawson)

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