Japan hinted Friday it could freeze its plan to buy South Korean government bonds as a deepening diplomatic rift over disputed islands threatened to spill over into economic ties.
The threat came as Japan's lower house of parliament passed its first resolution on the barren islets since 1953 and as Prime Minister Yoshihiko Noda said South Korea was "illegally occupying" them.
Noda told lawmakers his government "will act firmly" in response to South Korean President Lee Myung-Bak's visit to islands called Dokdo in South Korea and Takeshima in Japan.
Finance Minister Jun Azumi, who has already cancelled a planned trip to meet his counterpart in Seoul and suggested he would review a currency swap deal, said he was undecided if the bond purchase should go ahead.
"I would like to wait and see," he told a press conference, adding he would make a decision only after Lee apologised "for his excessive behaviour".
Japan, South Korea and China had agreed in May to hold each other's government bonds at a meeting of finance ministers and central governors.
Lee's August 10 visit to the Seoul-controlled islets badly riled Tokyo.
Comments a few days later in which he said Emperor Akihito had to apologise over crimes committed by Japan during its occupation of the Korean peninsula if he ever wanted to visit South Korea compounded the problem in Japanese eyes.
Japan's lower house Friday adopted a resolution that "strongly condemns" Lee's visit and his comment on the emperor, adding Japan "strongly demands that South Korea halt its illegal occupation of Takeshima as soon as possible".
Noda reiterated Lee's comment on the emperor "is difficult to comprehend" and the president should "apologise for and retract it".
"We will seek a fair, sober-minded and peaceful solution based on international laws" on the issue, he said.
Noda's comments came the day after a diplomatic dance over a letter he sent to Lee, which saw Seoul eventually sending the unopened note by registered mail after Japan refused to accept it back.
Japanese Foreign Minister Koichiro Gemba said Friday Japan would not try to send back the Japanese premier's missive, saying "to continue this kind of exchange is unfavourable in terms of the dignity of our country's diplomacy".
Seoul's foreign ministry on Friday called in a Japanese diplomat and delivered a protest letter over Gemba's earlier remarks describing South Korea's control over the island as an "illegal occupation."
"While delivering the protest letter, we also expressed a stern message over the inappropriate remarks" by Gemba, an official of the South Korean ministry said.
Gemba was scheduled to meet with the South Korean ambassador to Japan later Friday.
Minister of Agriculture, Forestry and Fisheries Akira Gunji said his ministry will "pay attention so that there will be no impact on cooperation in fishery and cross-border trade" between Tokyo and Seoul.
Despite strong economic ties, Tokyo and Seoul have an uneasy relationship, with the 1910-1945 Japanese occupation of the Korean peninsula a source of continuing friction.
US analysts have voiced concern that the flare-up between its northeast Asian allies has set back broader interests in the region, where concerns remain high over North Korea and China's rising clout.
Japan's ties with China have also been thrown into disarray with a squabble over islands known as Diaoyu in Chinese and Senkaku in Japanese, which are also claimed by Taiwan.
Lower house lawmakers also adopted a resolution condemning a visit to the islands by pro-Beijing activists.
On the territorial row with China, Noda said his government will "make utmost efforts to prevent a repeat of the illegal landing" through strengthening Japan's coast guard and diplomacy.
Noda will hold a news conference later Friday and will speak on both disputes, the top government spokesman said.