JGBs inch up on BOJ hopes, buy-back after pension fund news
* BOJ may extend maximum lending period to 2-3 yrs
* Extended lending seen as no panacea for JGB volatility
* Some short-covering after Friday's pension fund news misread
* JGB implied volatility refuses to go down despite BOJ hopes
TOKYO, June 10 (Reuters) - Japanese government bond prices edged up, underpinned by hopes that the Bank of Japan may take steps to reduce volatility in the bond market at a two-day policy meeting that began on Monday.
Also propping up the market was short-covering by investors who had sold bonds on Friday following news that Japan's public pension fund would cut the bond weighting in its model portfolio.
The change merely allows the $1 trillion fund to avoid rebalancing and stick to the current portfolio, rather than prompting it to sell JGBs outright as some had imagined.
"The market is helped by hopes for the BOJ's decision tomorrow," said Tomohiro Miyasaka, analyst at Credit Suisse.
Investors think the Bank of Japan may extend the maximum duration of its regular 0.1-percent lending programme beyond one year, to two or even three years.
Such a measure would likely bring down yields on short-term bonds, which in turn would help curb volatility in the longer end of the yield curve, market players say.
The September 10-year JGB futures, which took over the benchmark status from June contracts on Monday, rose 0.14 point to 142.94 .
The yield on the current 10-year cash bonds fell 1.5 basis point to 0.835 percent. The five-year yield slipped 0.5 basis points to 0.280 percent, near a four-week low of 0.265 percent hit on Friday.
Hopes for the BOJ's action offset the headwind from a rise in U.S. bond yields and Japanese share prices following Friday's solid U.S. employment data.
Japan's Nikkei average rose 4.9 percent from Friday's two-month low while the yield on 10-year U.S. Treasury notes rose to near a 13-month high hit last month after U.S. payrolls rose by 175,000 in May, above the 170,000 expected in a Reuters poll.
Still, many investors believe extended lending by the BOJ can only do so much in limiting volatility, as the ultimate source of instability in the bonds market in the past couple of months is the BOJ's pledge to boost inflation to 2 percent in two years.
While most investors think the pledge is unrealistic and that the BOJ will eventually back down on it one way or another, some are concerned that Governor Haruhiko Kuroda could expand his radical monetary easing even further into uncharted territory.
"You never know what Kuroda will do," said a fund manager at a Japanese asset management firm. "He seems to be blindly pursuing easing or is willing to do something when there is political pressure."
In a sign investors do not expect market volatility to come down any time soon, implied volatility on JGB options remained high, with many regular seller of JGB options unwilling to sell now.
The implied volatilities on JGB futures stood well above 5 percent, compared with just above 2 percent before BOJ Governor Haruhiko Kuroda stunned investors in April with his plan to double the monetary base in two years.
JGBs volatility spiked as the BOJ's aggressive pursuit of inflation - an enemy of bond investors - shocked markets while its big bond-buying plan has reduced market liquidity.
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