JGBs drop as US bank earnings reassure investors

By Eric Burroughs

TOKYO, April 21 (Reuters) - Japanese government bonds slid on Monday, pushing benchmark yields to a seven-week high as a slew of U.S. bank earnings last week reassured investors that the worst of the credit crisis may have passed. A big jump on Wall Street following the array of quarterly results pushed the Nikkei stock average .N225 up as much as 2 percent to a seven-week high, which spurred selling of safe-haven government debt.

As financial markets show signs of calming from the turmoil that erupted last August, investors now see little chance of the Bank of Japan cutting rates from 0.5 percent and are starting to brace for a potential rate hike next year.

Swap contracts on the overnight call rate <JPONIBOJ=TRDT> are now showing a nearly 20 percent chance of a quarter-point rate hike by next April. Earlier in the month the contracts had priced in a 50-60 percent chance of a rate cut by the end of the year.

But analysts said the market would be slow to embrace the prospect of higher rates just yet, given the severity of the crisis stemming from defaults on U.S. mortgages that have damaged banks in the United States and Europe.

"Markets have interpreted this as the end of the worst. We don't believe that's the case, so it's a good time to accumulate long positions," said Maki Shimizu, an interest rate strategist at UBS.

Highlighting the ongoing hit to balance sheets, sources told Reuters that Royal Bank of Scotland's board met over the weekend to discuss write-downs of as much as $14 billion and a rights issue of $24 billion. [ID:nL19436233] June 10-year futures 2JGBv1 dropped 0.45 point to 138.15 and struck a seven-week low of 138.08.

The benchmark 10-year yield <JP10YTN=JBTC> rose 4.5 basis points to a seven-week high of 1.440 percent.

The two-year yield <JP2YTn=JBTC> rose 1.5 basis points to 0.660 percent, the highest since early January. The five-year yield <JP5YTN=JBTC> climbed 3 basis points to 0.950 percent.