JGBs edge up on shaky Nikkei, Fed meeting awaited
* JGBs edge up, Fed meeting next potential market driver
* Two-year auction seen smooth on BOJ rate hike doubts
* Investors already expect dismal tankan survey next week
TOKYO, June 24 (Reuters) - Japanese government bonds drifted up on Tuesday as Tokyo stocks dipped, with many investors sticking to the sidelines to see whether the Federal Reserve will signal more worries about inflation after a two-day meeting.
The Nikkei share average .N225 was stuck slightly in negative territory and helping underpin a rebound in JGBs that has tugged benchmark yields down from 11-month highs hit last week.
Bond trading was subdued as market players wait to see if the Fed will try to dampen expectations for at least two quarter-point interest rate hikes this year. The looming end of the second quarter was also keeping investors shy about trading.
The main event of the day is a 1.7 trillion yen ($15.8 billion) auction of two-year notes, which analysts expect to draw good demand because short-term yields are seen as attractive as long as the Bank of Japan is likely to keep rates on hold in coming months.
The coupon was set at 0.9 percent on the new issue, matching that of the No.269 two-year JGB sold last month. TENDER21
JGBs have settled as investors have turned more confident that the market has weathered the worst of a fierce sell-off.
Doubts about how quickly the BOJ could lift rates have also helped the market recover.
Those doubts were reinforced after the Ministry of Finance's quarterly business survey showed sentiment hitting a four-year low in the April-June quarter, pointing to a poor reading in the BOJ's June tankan survey due next Tuesday.
"The JGB market has stabilised because stocks are weak and the market is not expecting a BOJ rate hike in the near future," said a senior trader at a European investment bank.
But JGB strategists at Barclays Capital said a dismal tankan is now already widely expected, and other factors would be necessary to push yields lower.
"In this context, we expect the market to start moving into a range until a new incentive appears," they said in a note to clients.
September 10-year futures 2JGBv1 edged up 0.18 point to 134.18, well above the 11-month low of 132.05 struck in mid-June.
Futures remain prone to sharp swings because total positions in the market remain low, with open interest holding close to a four-year low.
Benchmark 10-year yields JP10YTN=JBTC edged down a basis point to 1.705 percent, down 19 basis points from the 11-month peak of 1.895 percent struck last week.
The five-year yield JP5YTN=JBTC was steady at 1.295 percent, while the two-year yield JP2YTN=JBTC was down half a basis point at 0.840 percent.
The Fed decision, due after its meeting wraps up on Wednesday, could be the trigger for whether JGBs extend their rebound or it runs out of steam.
Reports over the past week have indicated that senior Fed officials believe they will keep rates on hold for the next few months unless the inflation outlook worsens and that the building expectations for multiple rate hikes were overdone.
The expectations for major central bank to lift rates stems partly from the European Central Bank flagging that a quarter-point increase to 4.25 percent is likely in July. ($1=107.82 yen) (Editing by Hugh Lawson)
