Japan's ruling party unveiled on Thursday a $154 billion stimulus plan, around 3 percent of GDP, to battle a deepening recession but the prospect of record sales of government debt to pay for it spooked the bond market.

The top government spokesman said 10-11 trillion yen ($100-$110 billion) in bonds may be needed to pay for Japan's biggest stimulus plan ever, which would raise issuance of new bonds by a third to 44 trillion yen in the year to March 2010.

Share investors were more impressed with a package that analysts said could lift Japan's GDP by around 1.5 percent.

The benchmark Nikkei share average jumped 3.7 percent to its highest close in three months.

With a likely close election due within months the government is under pressure to kickstart the economy as the global crisis has sent exports and corporate profits diving, prompting firms to cut production and lay off thousands of workers.

Shares jumped in companies seen gaining from its green-tinged backing for sales of solar panels and environmentally friendly cars but others warned the package would leave Japan with a debt hangover.

The contents look like temporary measures to front-load demand, but they do not pay attention to increasing productivity on the supply side, said Masamichi Adachi, a senior economist at JPMorgan.

This may contribute to GDP for a year. The consequences over the longer term are negative as we are piling up more of a fiscal burden. Bond issuance will go up from here on.

The package dwarfed three previous government economic packages in the past year to fight the effects of the global financial crisis and brought total stimulus spending to around 5 percent of GDP.

The plan, released by the ruling Liberal Democratic Party (LDP), was unlikely to be changed significantly ahead of a formal government announcement on Friday.

But the package faces a potentially stormy ride through parliament, where the opposition controls the upper house and can stall legislation and an extra budget to finance it.

Aso has threatened to bring forward an election due by October this year if the opposition delays the package.

BONDS SWOON, SHARES RALLY

The worries about the government's need to issue much more debt and rising long-term rates have caused a sharp steepening of the yield curve for government bonds.

The spread between two- and 20-year yields reached 170.5 basis points this week, its widest level in three years, while the yield on benchmark 10-year government bonds touched a five-month high on Thursday.

Continued rises in bond yields could put further pressure on the Bank of Japan to buy more government debt.

Last month it increased its purchases of government bonds by nearly a third in a move seen as capping long-term yields and making it cheaper for the government to borrow.

In the 15.4 trillion yen package, the LDP pledged more loans for hard-pressed small businesses, support for the jobless and subsidies for solar panels and environmentally friendly cars.

Shares in Toyota Motor Corp, maker of the Prius hybrid, rose 4.3 percent, while those of Sharp Corp, the world's No.2 maker of solar cells, surged 10.7 percent.

The Japanese economy shrank 3.1 percent in October-December from the previous quarter and is expected to have shrunk a further 2.5 percent in January-March.

The contraction is bigger than in other major economies, despite Japan's banking system being among the least damaged by the credit crisis, because of the country's reliance on exports of cars and electronics.

($1=99.70 Yen)

(Additional reporting by Leika Kihara, Stanley White, Yuzo Saeki and Tetsushi Kajimoto)

Japan Nikkei 225