JGB futures strike 2-yr high on rate expectations

By Rika Otsuka

TOKYO, Jan 11 (Reuters) - Japanese government bond futures hit a two-year high on Friday, as the market has started to factor in the possibility that a slowing U.S. economy and lower U.S. interest rates could prompt the Bank of Japan to cut rates.

Swap contracts on the BOJ's overnight call rate JPONIBOJ=TRDT show the market is pricing in a roughly 15 percent chance of a rate cut by the year-end.

"The JGB market is firmly supported as OIS contracts are now implying the possibility of a BOJ rate cut," said a bond trader at a foreign investment bank.

JGBs started the day mostly weaker as share prices rose in early trade.

But government debt changed course as Tokyo stocks gave up gains, with the Nikkei share average .N225 hitting a 19-month low in morning trade. [.T]

March JGB futures 2JGBv1 rose 0.40 point to 138.16 after climbing as high as 138.20, their highest since January 2006, two months before the BOJ ended its quantitative easing policy.

The 10-year yield JP10YTN=JBTC dipped 1 basis point to 1.425 percent, a fresh one-month low.

JGBs have rallied in recent months as investors increasingly doubt the BOJ will boost the benchmark overnight call rate from 0.5 percent this year.

That view was reinforced after Federal Reserve Chairman Ben Bernanke acknowledged on Thursday that the U.S. economy faces increased risks and indicated the Fed is ready to cut interest rates aggressively. [ID:nN10198225]

Barnanke's comments cemented expectations the U.S. central bank will lower the federal funds rate by a hefty half-point from the current 4.25 percent at its Jan. 29-30 policy meeting.

That came a day after BOJ Deputy Governor Toshiro Muto said the U.S. economic slowdown was accelerating and there was a need to consider the possibility of it worsening, adding that a slowdown in Japan was likely to continue in the near term.

Shorter maturities, which are more sensitive to changes in the monetary policy outlook, outperformed the rest of the market.

The two-year yield JP2YTN=JBTC fell 3.5 basis points to 0.600 percent after falling as low as 0.595 percent, the lowest since September 2006.

The five-year yield JP5YTN=JBTC slid 1.5 basis points to 0.900 percent, a fresh two-year low.

The 20-year yield JP20YTN=JBTC edged down 0.5 basis point to 2.080 percent.

But the 30-year yield JP30YTN=JBTC rose 2 basis points to 2.360 percent, hurt by hedge-selling ahead of a 30-year debt auction next week. (Editing by Michael Watson)