JGB futures inch up as credit jitters hit stocks
* JGBs up, financial worries push stocks down more than 1 pct
* Gains limited after Monday's unexpected surge
* 20-yr bond auction seen OK, institutional investors to buy
TOKYO, Aug 26 (Reuters) - Japanese government bond futures climbed towards a four-month high on Tuesday as renewed worries about the health of the U.S. financial sector spooked investors and spurred selling of stocks.
Gains were limited after JGBs surged unexpectedly the previous day as a bout of short-covering by some speculators caused a frenzy of buying in futures that dragged the entire market with it.
Analysts said the market seems to be settling into a lull around current yield levels, with benchmark yields holding around 1.4 to 1.5 percent as the economy has stalled and the Bank of Japan has made clear it has a neutral policy stance.
BOJ Governor Masaaki Shirakawa reaffirmed that view on Monday, saying in a speech in Osaka that central banks should be careful about the negative effects of keeping rates too low. He also downplayed the risk of a lengthy economic contraction. [ID:nT367953]
The BOJ is expected to keep interest rates on hold at 0.5 percent for several months, but a cut is also seen as very unlikely because policy rates are already so low. Money market futures are showing little chance of either a rate hike or cut.
For that reason, JGB yields can only fall so far even if yields on U.S. Treasuries keep dropping, analysts said.
Dealers are preparing for an 800 billion yen ($7.3 billion) auction of 20-year bonds during the day.
The sale is not expected to cause too many waves in the market, however, given persistent demand for long-term paper from institutional investors such as life insurers.
"I think we will see good demand for long bonds," said Kenro Kawano, a senior interest-rate strategist at Credit Suisse.
"Life insurers and pension funds realise the worsening condition of the economy, and that means they are not looking for any significant increase in yields."
The coupon was set at 2.1 percent, down from 2.3 percent at last month's issue and the lowest since February.
September 10-year futures 2JGBv1 edged up 0.17 point to 138.27, holding near a four-month peak of 138.39 struck the previous day.
The benchmark 10-year yield JP10YTN=JBTC was flat at 1.425 percent, just above a four-month low of 1.405 percent touched on Monday.
The five-year yield JP5YTN=JBTC dipped half a basis point to 0.990 percent, and the 20-year yield JP20YTN=JBTC drifted up half a basis point to 2.115 percent.
Investors are also keeping an eye on an expected economic package that the Japanese government has said it will outline this week, with any extra bond issuance to fund the spending seen as a potential negative for the market.
The ruling Liberal Democratic Party's policy chief said on Monday the package could be worth 2-3 trillion yen ($18-27 billion), and the cabinet has agreed to start preparing for an extra budget to finance the spending. [ID:nT314446]
LDP officials have taken pains to say the package is intended to provide relief to households and companies struggling with steep costs and not a return to the massive spending projects of the past that have left Japan saddled with huge public debt.
Kawano said a bigger issue for the JGB market is that the economic downturn should erode tax revenues just as social spending is increasing for the ageing population, potentially leading to more long-term bond issuance in the next fiscal year.
In the stock market, the Nikkei average .N225 fell 1.3 percent by midday, with financial shares leading the way after a drop on Wall Street sparked by the ninth U.S. bank failure this year. Worries about more asset write-downs sent shares of AIG to a 13-year low. [.T] ($1=109.30 Yen) (Editing by Michael Watson)
