JGBs slip as Nikkei recovers from tumble

By Eric Burroughs

TOKYO, Jan 17 (Reuters) - Japanese government bonds fell on Thursday, with futures pulling back from a two-year high as Tokyo stocks staged a mild recovery from this year's sharp sell-off.

The Nikkei share average .N225 rose 1.3 percent to stem a tumble since the start of the year that has driven the market to its lowest levels since 2005 on mounting fears about the impact on Japan of the yen's rise and a potential U.S. recession.

A fall in Treasuries overnight also dragged JGBs lower as investors took profits on the U.S. bond market's surge on speculation that the Federal Reserve could cut rates by a half percentage point even before its meeting at the end of the month.

JGBs have jumped recently as the darkening economic outlook in both the United States and Japan have led market players to consider the possibility of the Bank of Japan cutting interest rates later in the year rather than lifting them.

Analysts said the market was caught in a tug-of-war between low yields and the influx of cash seeking the safety of government bonds and bills.

"The bond market is stuck between good demand and high valuation," said Nhan Ngoc Le, a bond strategist at ABN AMRO.

March 10-year futures 2JGBv1 fell 0.05 point to 138.16 but held near the two-year peak of 138.29 reached the previous day.

The benchmark 10-year yield JP10YTN=JBTC climbed 1.5 basis points to 1.395 percent after touching a 28-month low of 1.380 percent the previous day.

The five-year yield JP5YTN=JBTC was unchanged at 0.860 percent, up from a two-year low of 0.850 percent on Wednesday. The two-year yield JP2YTN=JBTC slipped half a basis point to 0.580 percent.

JGBs got a boost the previous day from a solid auction of five-year paper that showed steady demand, even though the coupon on the offering was the lowest in two years.

Futures contracts on the overnight call rate show a 25 percent chance of a rate cut in June from the current 0.5 percent and a 30 percent chance of a cut in September, according to data from Meitan Tradition JPONIBOJ=TRDT.

Many market players believe a rate cut is unlikely but say a BOJ shift in its policy stance will depend on who succeeds governor Toshihiko Fukui, whose term expires in March.

Nhan at ABN AMRO also said investors have shifted huge amounts of funds into the yen money market, pulling down short-term yields and distorting how much the market is pricing in the risk of a BOJ rate cut.