JGBs rise on Nikkei drop, eyes on BOJ rate verdict
*Futures rise on Nikkei drop
*Five-year yield drops further to 6-month low
*Investors waiting to see if BOJ will cut rates
TOKYO, Oct 31 (Reuters) - Japanese government bonds rose on Friday as Tokyo shares fell, but trading activity was muted with investors nervously waiting to see if the Bank of Japan will cut interest rates later in the day.
Investors believe monetary easing by the BOJ at Friday's meeting is almost inevitable after share prices around the world rallied this week on optimism that rate cuts by major central banks will ease a looming global recession. [ID:nT242225]
If the BOJ cuts rates it would be the first such move in seven years. Governor Masaaki Shirakawa is to speak at a news conference in the afternoon.
"If the result is other than a 25 basis point rate cut, the yen could rebound sharply and stocks may fall. JGBs could rally as a result and move in such a way as to create pressure for an interest rate cut," said Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Securities, in a note to clients.
December futures 2JGBv1 climbed 0.48 point to 138.39 after rising more than half a point as the Nikkei share average .N225 fell about 4 percent at one stage in early trade.
The benchmark 10-year yield JP10YTN=JBTC dipped half a basis point to 1.480 percent after falling as low as 1.455 percent.
Short- and medium-term maturities -- sectors sensitive to a shift in expectations on BOJ monetary policy -- extended their gains with investors hoping to see bond prices rise further if the BOJ actually cuts rates.
The five-year yield slid as low as 0.855 percent, a six-month low, before retreating a tad to 0.860 percent, JP5YTN=JBTC down 2.5 basis points on the day.
The two-year yield JP2YTN=JBTC fell half a basis point to 0.580 percent, near a six-month low of 0.560 percent marked on Thursday.
"The market still only half believes in a BOJ rate cut," said a bond trader at a Japanese bank.
"If the BOJ lowers rates, short-term bond yields should fall further," the trader said.
Market players had believed until earlier this week that the BOJ would only cut rates as a last resort after the central bank opted to broaden its money market operations earlier this month, since overnight rates are already set at a low 0.5 percent.
When major central banks cut rates in a coordinated move earlier this month, the BOJ did not participate.
The swap contract on the overnight call rate JPYOISBOJ=TKFX indicated that investors now see a roughly 70 percent chance of the BOJ cutting interest rates to 0.25 percent from the current 0.5 percent later in the day.
A BOJ rate cut would be aimed at combating the global financial crisis in concert with other major central banks. The U.S. Federal Reserve cut interest rates this week and the European Central Bank is expected to follow suit next week.
Longer-dated bonds were supported by expectations that many pension funds will buy the bonds after confirming a BOJ rate cut to settle month-end trading, traders said.
The 20-year yield dipped 2 basis points to 2.110 percent JP20YTN=JBTC and the 30-year yield slipped 2.5 basis points to 2.235 percent. JP30YTN=JBTC
The market showed little reaction to a slew of domestic data showing Japan's unemployment rate fell in September and the nation's core annual inflation slowed in the same month to match market expectations. (Editing by Michael Watson)
