TOKYO - New Japanese Prime Minister Yukio Hatoyama took office Wednesday, launching an untested government pledged to radically change how the nation is run and make domestic demand, not exports, the engine of growth.

Hatoyama's Democratic Party of Japan (DPJ) trounced the long-ruling Liberal Democratic Party in last month's election. He now faces pressure to make good quickly on promises to focus spending on consumers, cut waste and reduce bureaucrats' control over policy.

He must also try to ensure that a nascent recovery from Japan's worst recession since World War Two stays on track despite an already huge public debt.

Managing ties with close ally the United States while charting a more independent course will be a further priority.

I want to create the kind of politics in which politicians take the lead without relying on bureaucrats, the 62-year-old Hatoyama, wearing his lucky gold, silver and blue striped tie and signature pocket handkerchief, told his first news conference.

We might make mistakes as we do things by trial and error. We want the people to be tolerant...We would appreciate if the people nurture the new government with patience.

Hatoyama's cabinet, a balance of former Liberal Democrats, ex-socialists and younger conservatives, will have to hit the ground running.

The DPJ has got to come up with an agreed list of priorities quickly, because its manifesto is just a long laundry list, said Koichi Nakano, a professor at Sophia University in Tokyo.

Hatoyama's choice of veteran lawmaker Hirohisa Fujii, 77, as finance minister has soothed some concerns about government spending and the debt burden, but the former finance mandarin moved currency markets even before he was sworn in.

The yen rose 0.9 percent to a new 7-month high against the dollar after he said a strong yen had merits for the economy and that recent currency moves were not rapid.

The choice of Shizuka Kamei, the outspoken head of a tiny coalition partner and an opponent of market-friendly reforms, as minister for banking and market regulation sent bank shares lower with comments on lending.

INDEPENDENT DIPLOMACY, BUDGET BATTLES

Hatoyama's vow to steer Japan on a more independent diplomatic course has sparked concerns about possible friction with top ally the United States ahead of his diplomatic debut there next week, where he will meet President Barack Obama.

The U.S.-educated Hatoyama is expected to reassure Obama over ties and perhaps postpone calls for renegotiation of agreements on U.S. troops stationed in Japan.

The first step will be to build a trusting relationship with President Obama, Hatoyama said. Japan has tended to have a passive role in its relationship with the United States. We want an active role. We want the kind of relationship where we can tell one other what we are thinking frankly.

On his return, Hatoyama faces the urgent task of drafting a budget for the fiscal year from next April 1 and finding ways to plug holes in this year's budget caused by sliding tax revenues as Japan struggles out of a recession.
The new government must balance the need to nurture a recovery and fund its consumer-friendly spending plans with concerns about a public debt heading toward 200 percent of

GDP.

People aren't fools. We know that money has to come from somewhere, but I just don't know where, said 50-year-old businessman Eiji Shimagami.

The Democrats have promised to scrap public works projects and other programs they consider wasteful and use freed-up cash to stimulate consumption through measures such as payouts to farmers and families with children, and ending highway tolls.

Hatoyama told reporters he thought his government could secure the 7 trillion yen ($77.54 billion) it says it needs to fund its policies in 2010/11, starting next April. It was vital, he said, to relieve the burden on households given an uncertain economic outlook.

The economy returned to slow growth in the second quarter, but still suffers a record high jobless rate and record deflation.

The Democrats have vowed to centralize decision-making in the cabinet, and a new National Strategy Bureau will be tasked with reforming what the Democrats say is a cumbersome policy-making system that relied heavily on recommendations from bureaucrats.

That means the finance minister will likely share responsibility for the budget with former Democratic Party leader Naoto Kan, who will head the new bureau.

Kan, who battled bureaucratic corruption as health minister in the 1990s, is seen as a pragmatic force for change.

Hatoyama must also hold together an awkward coalition with the two tiny parties whose support he needs in parliament's upper house, and may face fallout from money scandals looming over him and party No.2 Ichiro Ozawa.

Besides conservative People's New Party head Kamei, he named Social Democratic Party leader Mizuho Fukushima to take charge of consumer affairs and policies to boost a very low birthrate.

($1=90.27 Yen)

(Writing by Linda Sieg; Additional reporting by Chisa Fujioka, Yoko Nishikawa and Colin Parrott; Editing by Ron Popeski)

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