JGB futures slide on hedge-selling before auction

TOKYO, March 31 (Reuters) - Japanese government bond futures fell on Monday, giving up earlier gains made on a sharp fall in stock prices, as dealers sold bonds to hedge against a 10-year debt auction the following day.

JGB futures jumped in early trade on a sell-off in the Tokyo stock market and a boost from by Friday's rise in U.S. Treasuries due to persistent worries about the health of the financial sector.

Trading activity was light, exaggerating moves in the market, as many investors sat on their hands on the last day of Japan's fiscal year. Many Japanese firms close their books on Monday.

"JGB futures as well as 10-year cash bonds were dragged down in afternoon trade ahead of Tuesday's debt sale," said Tatsuo Ichikawa, fixed-income strategist at ABN AMRO Securities.

June 10-year JGB futures fell 0.15 point to 140.52 2JGBv1. They had risen as high as 141.13.

The benchmark 10-year JGB yield edged up 0.5 basis point to 1.275 percent JP10YTN=JBTC, holding above a three-year low of 1.215 percent struck last week. The yield dropped as far as 1.235 percent earlier in the session.

The benchmark yield ended the previous fiscal year at 1.650 percent. It hit the current fiscal year's peak of 1.985 percent in June but started to slide as the global market turmoil sparked flight-to-quality buying of government bonds.

The Nikkei share average .N225 slid 2.3 percent on Monday, finishing the fiscal year with its worst quarterly performance since 2001.

In the money market, the Bank of Japan offered to supply funds totalling a record 3 trillion yen ($30 billion) via a same-day operation to temper rises in the overnight call rate at the end of the quarter and the fiscal year.

Traders said that earlier in the session, Japanese banks had sought overnight funds at as high as around 0.62 percent while foreign banks were seen raising money at as high as near the BOJ's 0.75 percent Lombard rate for direct lending to banks.

Japanese money markets have been generally stable despite volatility in overseas markets, which have been hit harder by the global credit crunch.

TANKAN, AUCTION, JOBS DATA

In the near term, JGBs will likely be supported by worries about the outlook for the U.S. and Japanese economies and share prices, although gains could be tempered by profit-taking and by fresh bond supply including the 10-year JGB auction on Tuesday, analysts said.

JGBs have drawn support from market expectations that high-profile data due this week could underscore fears of a U.S. recession and fan worries about the knock-on effects on Japan.

The BOJ's tankan survey of business sentiment is due on Tuesday, while U.S. jobs data will be released on Friday.

Investors may start to take more seriously the possibility of the BOJ lowering interest rates in coming months if such data comes in weak, analysts said.

Swap contracts on the overnight call rate show that investors now see a 25 percent chance of a BOJ rate cut by June, while the chances of a rate cut by year-end are seen at nearly 60 percent. JPONIBOJ=TRDT

The tankan is expected to show a sharp deterioration in corporate sentiment due to the global credit crisis, rises in raw material costs and a fall in the dollar. [ID:nT38177]

In addition, equity markets may remain jittery over the next couple of weeks until some major U.S. banks announce their quarterly earnings in April, said Chotaro Morita, head of fixed income strategy in Japan for Barclays Capital. [RESF/US] "U.S. financial sector shares were weak on Friday and there is a possibility that moves in equity markets could be cautious for the next week or two. That could lend support to bond markets in both Japan and abroad," Morita said.

The 20-year yield JP20YTN=JBTC climbed 2.5 basis points to 2.075 percent, while the two-year yield JP2YTN=JBTC dipped 0.5 basis point to 0.565 percent. The yield curve steepened, as a result. ($1=100.00 yen) (Additional reporting by Chikako Mogi and Masayuki Kitano; editing by Brent Kininmont)