JGBs rise as calm returns, supported by Nikkei dip

By Masayuki Kitano

TOKYO, June 5 (Reuters) - Japanese government bond futures rose on Thursday, supported by a dip in equities, as some calm returned to the market after recent volatility.

JGB 10-year yields hit 10-month highs last week but gained some reprieve two days ago, as concern over mounting inflationary pressure gave way to worries about losses at major financial institutions. Credit fears helped JGB futures match their biggest one-day rise in five years on Tuesday.

The recent volatility in JGBs has made dealers and investors more wary about taking on risk.

With the Bank of Japan still seeing downside risks to economic growth in the near term, JGBs were drawing some support as 10-year yields hovered near the 10-month high of 1.805 percent hit last week.

"We are not at a stage where market expectations about changes in short-term interest rates are likely to accelerate," said Chotaro Morita, chief fixed income strategist for Japan at Barclays Capital.

June 10-year JGB futures 2JGBv1 rose 0.50 point to 135.18 2JGBv1.

The benchmark 10-year JGB yield fell 2.5 basis points to 1.745 percent JP10YTN=JBTC.

JGBs drew some support from a 1 percent .N225 fall in the Nikkei share average.

Bank of Japan Governor Masaaki Shirakawa said on Tuesday that keeping Japan's interest rates low for too long could entice investors to take excessive risks, and warned of increased upward risks to inflation.

But while Shirakawa said that growth was likely to pick up in late 2008 and in 2009, he said there were downside risks. [ID:nL03608440]

U.S. Treasuries fell sharply on Wednesday after Federal Reserve Chairman Ben Bernanke added to bond investors' fear of inflation, saying rising longer-term inflation expectations were a "significant concern" for the central bank. [US/]

Investors are also looking towards an auction of 10-year inflation-indexed JGBs on Thursday.

The Ministry of Finance's offer of 500 billion yen ($4.75 billion) in consumer price index-linked bonds is seen as likely to draw stronger demand than Tuesday's 10-year JGB auction, which met with tepid demand.

In March, the break-even inflation rate, or the difference between the yield on benchmark fixed 10-year JGBs and CPI-linked JGBs, fell into negative territory as index-linked paper was battered by overseas-investor selling.

But it has since recovered to around 35 to 40 basis points as the recent surge in oil prices to record highs fuelled concerns about inflationary pressures.

The fact that oil prices CLc1 have retreated from record highs hit in late May could curb demand at the auction, said Morita at Barclays Capital.