Toyota has confirmed it is developing a Yaris-based hybrid as it battles with Honda to become the first manufacturer to sell a hybrid supermini.
The decision is motivated by a need to counter Honda's plans to produce a hybrid Jazz, and respond to the Honda Insight's near-£3000 price advantage over the Toyota Prius.
Akihiko Otsuka, chief engineer of the third-generation Prius, said, "We are developing a low-cost hybrid vehicle like the Honda Insight.
"We are going to compete by expanding our hybrid vehicle line up to smaller hybrids, in the class of the Vitz (sold in Japan) and the Yaris."
Prices for the Honda Insight start from £15,490. By contrast, Prius prices start at £18,370. The next-generation Prius goes on sale in the UK in June.
Otsuka said that the top priority with the next Prius was to increase fuel efficiency and not to reduce the price.
Its petrol engine will increase from 1.5 litres to 1.8 litres to reduce high-speed fuel consumption.
Toyota has also developed most of the core components of the new Prius in-house, including the electric motor, inverter and lithium ion batteries. That has added to development costs that need to be recouped.
Reports from Japan suggest that the Yaris hybrid could go on sale in 2011.
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