* Hammering out a new budget top of government's agenda
* New PM must smooth ties with Washington next week
* Campaign promises (and how to pay for them) a key issue
By Isabel Reynolds and Yoko Nishikawa
TOKYO, Sept 16 (Reuters) - Japan's new leader Yukio Hatoyama will take office and finalise his cabinet on Wednesday, putting in place an untested line-up to tackle challenges ranging from restoring economic growth to managing ties with Washington.
Hatoyama, whose Democratic Party of Japan (DPJ) trounced the long-ruling Liberal Democrats in an election last month, faces pressure to make good on campaign promises to focus spending on consumers, cut waste, and reduce bureaucrat control over policy.
"I have mixed feelings of excitement about changing history and the very heavy responsibility of making history," said Hatoyama, whose party ousted the LDP for only the second time since its founding in 1955.
"The fight begins now."
Hatoyama's cabinet, a delicate balance of former Liberal Democrats, ex-socialists and younger conservatives, must 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.
"And it better not just be how they will govern differently, but actual policies," he added. "They can expect something of a honeymoon for a year, but not longer than that."
Hatoyama's choice of veteran lawmaker Hirohisa Fujii, 77, as finance minister has soothed some analysts' concerns that the government's spending programmes will inflate an already huge public debt as Japan struggles to emerge from recession.
But his choice of Shizuka Kamei, the outspoken head of a tiny coalition partner, as minister for banking supervision and postal services has spooked some experts worried about Kamei's opposition to market-friendly reforms.
"If foreign investors interpret Kamei's position as a slowdown for reform in Japan, stocks could come under pressure and this would be a buying factor for bonds," said Makoto Yamashita, a strategist at Deutsche Securities.
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 re-negotiation of agreements on U.S. troops stationed in Japan.
On his return, Hatoyama faces the urgent task of drafting a budget for the year from April 1 and finding ways to plug holes in this year's budget caused by sliding tax revenues as Japan struggles out of its worst recession since World War Two.
The new government must balance the need to nurture a recovery and fund its consumer-friendly spending programmes with concerns about a public debt heading towards 200 percent of GDP.
The Democrats have promised to scrap public works projects and other programmes they consider wasteful and use freed up cash to stimulate consumption through measures such as payouts to farmers and families with children and ending expressway tolls.
"They have to put together a budget that clearly shows them as different from the LDP and the finance minister will be at the centre of that," said Tsuneo Watanabe, a senior researcher at think tank The Tokyo Foundation.
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 centralise 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.
While pushing changes, Hatoyama must hold together an awkward coalition with the two tiny parties whose support he needs in parliament's upper house, and may face fall-out from money scandals looming over him and and party No. 2, Ichiro Ozawa.
Besides conservative People's New Party head Kamei, he will appoint Social Democratic Party leader Mizuho Fukushima to take charge of consumer affairs and policies to boost Japan's very low birthrate. (Editing by Linda Sieg and Rodney Joyce)