JGB futures fall on investor jitters before auction

By Chikako Mogi

TOKYO, June 2 (Reuters) - Japanese government bond futures fell on Monday as investors remained wary of a key 10-year bond auction due the following day.

The JGB market has not recovered from heavy selling over the past two months as investors shed government bonds built up while the global credit crisis deepened.

Some investors began buying bonds on dips after five- and 10-year yields rose to 10-month highs last week. But with many of them looking to further reduce their JGB holdings to limit losses, such a rebound offered a chance to take profits, traders said.

Players were also worried about the threat of mounting inflation pressures, and kept a close eye on overseas bond yields and potential interest rate hikes, including from the Bank of Japan.

The Ministry of Finance will offer 1.9 trillion yen ($18 billion) of 10-year JGBs on Tuesday, followed by an auction of 500 billion yen in 10-year inflation-linked bonds on Thursday.

"Players are cautious before the 10-year note auction and are taking profits from late last week's recovery in the market," said Chotaro Morita, chief JGB strategist at Barclays Capital.

"With market sentiment still bearish, the supply this week will be a challenge for investors as to how much they can absorb," he said, adding that any rebound in prices will likely be related to short covering.

June 10-year futures 2JGBv1 eased 0.14 point to 134.31, above the 10-month trough of 133.77 struck in Thursday's evening session.

The benchmark 10-year yield JP10YTN=JBTC was unchanged at 1.750 percent, off a 10-month peak of 1.805 percent hit late on Thursday.

Benchmark yields jumped about 20 basis points in May following a 30 basis-point surge in April -- the biggest two-month spike in yields since 2003.

The two-year yield JP2YTN=JBTC was up 1.5 basis points at 0.920 percent, just below a 10-month high of 0.925 percent hit on Friday. The level fully reflects expectations for a quarter-point rate increase from 0.5 percent in the months ahead as well as the possibility of another.

Traders said that if oil prices kept away from record highs, this would ease inflation worries and support the bond market.

Oil prices were little changed below $128 a barrel on Monday. CLc1

Traders also said they would closely watch the Institute for Supply Management's manufacturinug index for May due later in the day for clues on the health of the U.S. economy. Economists forecast a fall of 0.6 percent compared with a 1.1 percent drop in April. ($1=105.50 Yen) (Editing by Chris Gallagher)