JGBs edge up, rate worry weighs on short maturities

By Chikako Mogi

TOKYO, May 30 (Reuters) - Short-term Japanese government bonds slid on Wednesday, pushing the two-year yield to a 10-year high, as unexpectedly weak industrial output data did nothing to ease worries about the Bank of Japan lifting rates in the coming months.

Industrial production fell 0.1 percent in April from a month earlier, below a forecast 0.5 percent rise, but traders said the data failed to reverse mounting expectations for the BOJ to raise rates as soon August.

"The weak April data alone does not alter the view that the economy is growing in line with the Bank of Japan's basic scenario," said Makoto Yamashita, chief JGB strategist at Lehman Brothers.

But JGB futures edged up and long-term yields fell on a drop in stocks and as investors bet on a further flattening of the yield curve.

June 10-year futures rose 0.04 point on the day at 133.21 2JGBv1, rebounding to a session high of 133.32 as Tokyo shares tracked an initial drop in Shanghai stocks. The June contract hit a nine-month low of 133.04 early in the session.

China's benchmark Shanghai Composite Index .SSEC fell 6 percent after the government hiked the stock trading tax to cool speculation, dragging regional stock markets lower and prompting some players to cover short positions.

"The market remains under selling pressure. Some investors continued to buy when prices fell, but such dip-buying demand has been waning in recent sessions, keeping a cap on any rebound," said senior dealer at a Japanese bank.

The flattening of the yield curve pushed the spread between two- and 10-year yields to 76 basis points, matching a four-year low.

"There was steady dip-buying in long-term bonds among domestic institutional investors, helping to flatten the yield curve," said Hidenori Suezawa, chief strategist for Daiwa Securities SMBC.

The benchmark 10-year yield fell 1.5 basis points to 1.735 percent, after hitting a four-month high of 1.755 percent early in the session.

The two-year yield inched up 0.5 basis point to 0.975 percent JP2YTN=JBTC, a 10-year high. The two-year yield has risen about 10 basis points over the past week.

The December euroyen futures contract JEYv1 was up 0.5 basis point at 99.025, falling from a high of 99.035 hit in early trade after the production data.

Traders said market sentiment remained weak even as investors were still looking to buy bonds on dips, as many players remained wary of the chance of a BOJ rate hike.

"The surprise drop in output for April was less important for the market than the data showing the jobless rate falling to a 9-year low," said a dealer at a foreign securities firm.

JGBs took a beating on Tuesday as upbeat figures showing the jobless rate hit a nine-year low and robust household spending reinforced expectations of a BOJ rate hike in the coming months. (Additional reporting by Tetsushi Kajimoto)