JGBs inch up but kept in range, stock moves eyed

By Chikako Mogi

TOKYO, May 28 (Reuters) - Japanese government bonds edged higher on Wednesday but sentiment remained weak, weighed by gains in Tokyo shares and an overnight drop in U.S. Treasuries.

The market erased earlier losses when the benchmark 10-year JGB yield matched its highest level in nearly 10 months hit the previous day, while the five-year yield also rose to the highest in nearly 10 months.

The five-year maturity continued to underperform the rest of the curve as banks, major holders of medium-term notes, keep shedding their bond holdings built up during the worst of the credit crisis to cut losses they made when JGBs were slammed.

The sell-off in the JGB market was also driven by growing concerns about rising inflation pressures in Japan after years of deflation.

Oil fell $4 to $128 a barrel on Tuesday, pulled down by a stronger dollar and concerns that moves to cut Asian fuel subsidies could hurt demand.

But Treasuries fell on Tuesday, hurt by persistent inflation concerns after U.S. consumers' inflation expectations surged.

"The JGB market took a cue from Treasuries, which fell despite a drop in oil prices. JGB market players are now testing to see if the 10-year yield will hit 1.8 percent," said Naomi Hasegawa, senior JGB strategist at Mitsubishi UFJ Securities.

Volume remained thin, exacerbating price movements as investors largely stayed sidelined.

"There is buying interest from investors who had been hit hard by the recent sell-offs. The absence of buyers who normally buy when yields reach certain levels will likely push upward pressure on medium- and 10-year yields," Hasegawa said.

June 10-year futures 2JGBv1 fell as low as 133.99, just above a nine-month trough of 133.93 hit on Friday, before rising 0.14 to 134.49.

The benchmark 10-year yield JP10YTN=JBTC eased 1 basis point to 1.750 percent, after rising as high as 1.785 percent to match its highest level since Aug. 9 hit on Tuesday.

The five-year yield JP5YTN=JBTC rose 2 basis points to 1.355 percent after rising to 1.360 percent, its highest since Aug. 9.

The two-year yield JP2YTN=JBTC hit a seven-month high of 0.860 percent, up 1 basis point on the day.

Some traders said caution before the two-year note auction on Thursday may be weighing on the bonds.

The Ministry of Finance will offer 1.7 trillion yen ($16 billion) in two-year JGBs on Thursday.

The 20-year yield eased 1.5 basis points to 2.295 percent after an auction the previous day attracted good buying because of its 2.4 percent coupon, which was the highest in nearly four years.

The Nikkei share average .N225 was up 0.3 percent.

($1=104.26 Yen) (Editing by Chris Gallagher)