JGBs sag on Nikkei, pare some losses after auction

* JGBs trim losses after 5-yr auction draws fair demand

* Moody's JGB rating upgrade has little impact

By Shinichi Saoshiro

TOKYO, May 19 (Reuters) - Japanese government bonds slipped on Tuesday, coming under pressure from weaker U.S. Treasuries and a 2.8 percent surge in Tokyo's Nikkei stock average .N225 but paring some of the losses after a smooth five-year auction.

Japan's Ministry of Finance offered 2 trillion yen ($20.7 billion) of five-year JGBs on Tuesday for a reopening of the 0.8 percent coupon March issue, and market players said the mid-term bonds attracted demand from domestic banks.

Although the result came in as expected, the market was nevertheless relieved to see the lowest auction price come in at 99.97 after the bid-to-cover ratio, a gauge of demand, dipped to 2.64 from 2.80 at the previous offering in April. TENDER25

"The results of the auction were satisfactory and in line with expectations," said Keiko Onogi, a senior JGB strategist at Daiwa Securities SMBC.

"There was little prior concern of a bad auction, but the previous day's yield decline and the fact that the offering was a reopening prevented buyers from bidding aggressively," Onogi said.

The five-year yield rose 0.5 basis point to 0.795 percent JP5YTN=JBTC on Tuesday. It had hit 0.785 percent, nearing a six-week low the previous day on falling Tokyo shares.

Short to mid-term JGBs have gained support from the Bank of Japan's monetary policy, under which overnight interest rates are pinned at 0.10 percent, anchoring yields of those maturities.

That central bank policy, together with the large amount of government debt it buys outright every month, have helped the market absorb JGBs.

Starting in July, Japan will issue an additional 16.9 trillion yen of JGBs for the fiscal year through March 2010 to pay for a record economic stimulus package to tackle its worst recession since World War Two.

But the JGB market has so far taken the upcoming supply boost in stride and ample investor demand emerged at previous week's 10- and 40-year auctions.

Following Tuesday's auction, the market's focus is on the January-March quarter GDP numbers due on Wednesday, with economists polled by Reuters expecting Japan's economy to have shrunk 4.2 percent for the fourth straight quarter of contraction. [JPGDP=ECI]

While Japanese growth is seen returning to near its potential in fiscal 2010/11, economists said deflation --something that supports demand for bonds-- may persist for the next two years due to slack demand. [ID:nT160977]

Still, Japanese production and exports have recently shown some signs of a recovery.

"A poor GDP outcome is widely expected and priced in for the most part. JGBs are likely to react more to better-than-expected GDP numbers as a result," said Onogi at Daiwa Securities SMBC.

June 10-year JGB futures 2JGBv1 was 0.14 point lower at 137.17 after hitting a day's low of 136.94.

The benchmark 10-year yield JP10YTN=JBTC climbed 2 basis points to 1.420 percent. It hit 1.430 percent earlier in the day.

The 20-year yield rose 3.5 basis points to 2.085 percent JP20YTN=JBTC.

A ratings upgrade to JGBs by Moody's Investors Service on Monday had little impact on the market.

Moody's upgraded JGBs to Aa2 from Aa3, saying the domestic market was able to absorb new borrowing despite Japan being the most indebted government among industrialised countries. [ID:nT181044]

"The change by Moody's is unlikely to lead to a sudden shift in investment stance or market view as participants struggled to understand the logic behind the ratings move," said Tatsuo Ichikawa, a senior fixed-income strategist at RBS Securities. (Reporting by Shinichi Saoshiro; Editing by Edwina Gibbs)