By Tomasz Janowski and Stanley White
TOKYO (Reuters) - Japan turned up the heat on Friday in an emotional row with former colony South Korea, with lawmakers calling on Seoul to end its "illegal occupation" of a disputed island chain and the government considering scaling back economic ties.
Tension between the North Asian countries, both close U.S. security allies, flared this month after President Lee Myung-bak became the first South Korean leader to set foot on the islands claimed by both countries.
Lee's visit and his call for Emperor Akihito to go beyond expressing "deepest regrets" for Japan's 1910-1945 colonial rule triggered a diplomatic tit-for-tat feud, and a rare veiled threat from Japan to flex its economic muscle.
Finance Minister Jun Azumi reiterated on Friday that the government might not extend a currency swap arrangement with South Korea after it expires in October and said Japan was weighing an earlier plan to buy South Korean government debt.
"Things have reached the point where the Japanese people may not be able to accept the argument that political relations and economic relations are separate," Azumi told reporters.
In a symbolic but rare move, Japanese lawmakers passed a resolution condemning Lee's visit to the islands known as Dokdo in Korea and Takeshima in Japan, and demanded their return to Japan.
Noda, attacked by the opposition for being too soft in territorial rows, referred to South Korea's control of the islands as "illegal occupation", breaking with his and other prime ministers' past practice of avoiding such language.
"It is my understanding that they are being illegally occupied by South Korea," Noda said in reply to a question from an opposition member of parliament.
The Yomiuri newspaper reported that Japan was leaning towards aborting its planned purchase of South Korean government bonds, saying that the government believed it would not be understood by the public in the current diplomatic climate.
The dispute with South Korea coincides with a stand-off between Japan and China over another island chain, which sparked anti-Japanese protests in China last week.
Despite close economic ties, bitter memories of Japanese militarism run deep in China and South Korea. The simmering territorial disputes show how the region has failed to resolve differences nearly seven decades after the end of World War Two.
The row with South Korea sparked a curious stand-off over a letter from Noda to Lee, which South Korea first declined to accept and then Japan refused to take back.
Commentators say much of the war of words has to do with domestic political dynamics, with both Japan and South Korea facing elections and China preparing for a once-in-a-decade leadership change later this year.
A South Korean newspaper said Noda was trying a "diplomatic gamble" to shore up his dismal ratings ahead of an election his Democrats look set to lose.
However, in a sign that he was keen to prevent the stand-off from spinning out of control, Noda stressed the importance of partnership with Seoul.
"South Korea is our important neighbor and even difficult problems should be handled in a calm way and with a big picture in mind," he told the parliament.
(Editing by Linda Sieg and Robert Birsel)