JGBs dip, short-term yields stay near 2-year low

By Eric Burroughs

TOKYO, Jan 15 (Reuters) - Japanese government bond futures dipped slightly on Tuesday but short-term yields held near two-year lows as Tokyo stocks struggled to sustain gains.

The Nikkei share average .N225 climbed 0.4 percent, but the rebound was limited following a rally of more than 1 percent on Wall Street on Monday. March 10-year futures 2JGBv1 retreated 0.08 point to 137.93, backing off a two-year peak of 138.27 struck on Friday.

The yield on benchmark 10-year notes JP10YTN=JBTC edged up half a basis point to 1.425 percent. But the five-year yield JP5YTN=JBTC was flat at 0.885 percent, near a two-year low of 0.860 percent.

JGBs surged last week as worries mounted that Japan could suffer an economic recession this year along with the United States, forcing the BOJ to consider cutting rates from the current 0.5 percent.

Swap contracts on the overnight call rate JPONIBOJ=TRDT are pricing in a roughly 20 percent chance of a BOJ rate cut in the middle of the year, swinging sharply last week after having previously reflected a small chance of a rate hike.

But BOJ officials have stuck to their stance that interest rates need to rise, even while acknowledging the mounting risks to the global economic outlook. Most investors believe the BOJ will keep rates on hold unless conditions deteriorate sharply.

Kenro Kawano, an interest rate strategist at Credit Suisse, said BOJ officials tend to move gradually in changing their policy outlook.

"Since 2005, the market has tried to imply future rate hikes. If the opposite happens, the reaction should be quite big," Kawano said.

BOJ Governor Toshihiko Fukui told the central bank's regional branch managers on Monday that Japan's pace of growth is slowing because of a housing slump that has resulted from tighter building regulations but that the economy remains on a moderate expansion trend.

Investors will scour the BOJ's report on the performance of Japan's regional economies later in the day, which may highlight the troubles in the areas outside the urban centres.

Market players are also awaiting Citigroup's (C.N) quarterly earnings report later in the day to see the size of its asset write-downs from the credit crunch and what steps the largest U.S. bank is taking to shore up its depleted capital.

Several other banks and U.S. companies report earnings this week, including Merrill Lynch MER.N and JPMorgan Chase (JPM.N). (Editing by Mike Miller)