By Isabel Reynolds

TOKYO, Jan 17 (Reuters) - Japan's ruling party said on Thursday it was facing the worst crisis in its 50-year history, a day before a new session of parliament was to set the stage for a battle with the powerful opposition over fuel taxes.

The main opposition Democratic Party wants to cut the gasoline tax in a bid to win support from voters hit by soaring oil prices, while the ruling Liberal Democratic Party (LDP) plans to retain it to help fund public works such as road repairs in deeply indebted parts of the country.

Prime Minister Yasuo Fukuda called on the LDP to go all-out to boost the economy and overcome the public dissatisfaction that led to a drubbing at an upper house poll last year, handing the opposition the power to delay legislation.

"Today's party policy document calls this the worst crisis since the party was established," Fukuda told party members at a convention at a Tokyo hotel.

"I frankly admit this. I am painfully aware that you must all feel voters' lack of trust in politics and dissatisfaction with the LDP on a daily basis."

With fears of an economic downturn growing in Japan, as a Bank of Japan survey released on Wednesday showed consumer confidence at its lowest level in five years, rising prices are hurting consumers.

That is bad news for the LDP, whose support has already been battered by a long-running defence scandal and its handling of a row over millions of premiums paid into the public pensions system that were lost or pilfered by local officials.

"The way to fulfil people's expectations is to use the ruling party's power to bring economic growth to every area of the country," Fukuda told party members.

The ruling coalition on Thursday began a public relations battle for the fuel tax, emphasising its environmental importance.

"Other countries have raised their taxes for environmental reasons," top government spokesman Nobutaka Machimura told reporters on Thursday. "We have to think hard about the fact that Japan has not done so."

The Democrats hope the issue will gain enough momentum to help them deal another blow to the LDP and possibly even force a general election.

In one victory for the ruling coalition, Defence Minister Shigeru Ishiba on Thursday ordered Japanese ships to prepare to return to the Indian Ocean, where they will recommence refuelling in support of U.S.-led military operations in Afghanistan.

The Democrats had opposed an extension of the mission, which they said breached Japan's pacifist constitution because it did not have a U.N. mandate.

The government used its large majority in parliament's more powerful lower house to override the objections, a controversial tactic not used since 1951 that some warned could lead to claims of government bullying.

But polls show voters are more concerned about pocket book issues, such as the economic divide between cities and rural areas.

Democratic Party leader Ichiro Ozawa told his own party convention on Wednesday he would stake his career on the next general election, retiring from politics if the party failed to take power.

Though no election need be held until 2009, many analysts say the deadlock caused by the party divide between the upper and lower houses may push Fukuda into calling an earlier poll, despite flagging support rates.

He hinted this week that he would not do so before July, when Japan hosts the Group of Eight summit of industrialised nations. (Editing by Jeremy Laurence)

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