* JGB futures hit 7-yr high after BOJ easing
* Ten-yr/20-yr yield spread edges up towards 6-mth high
* Overnight call rate dips slightly after BOJ trims rates
* BOJ moves seen as first step towards reflationary policy
* But curve seen likely to flatten out to 10 years
By Masayuki Kitano
TOKYO, Oct 6 Japanese government bonds surged on Wednesday and the 10-year yield slid to a seven-year low, a day after the Bank of Japan eased monetary policy by cutting interest rates and unveiling an asset buying scheme.
The measures, including the plan to buy 5 trillion yen ($60 billion) in assets such as JGBs, real estate investment trusts and exchange-traded funds, are seen by some market players as a first step by the BOJ towards a more reflationary policy.
Market players say such measures are unlikely to give a quick boost to the economy, and gave little reason for investors to shy away from JGBs at this point.
With short- and medium-term JGB yields already offering a minimal spread over money market rates and expected to stay low after the BOJ trimmed the overnight call rate to near zero and pledged to keep rates there until the economy achieves price stability, investors flocked to long-term JGBs.
"When thinking about whether it's better to buy five-year JGBs with a yield of 20 basis points or 10-year bonds yielding more than 90 basis points, investors turned their gaze toward the 10-year sector," said a trader for a European brokerage house.
"I think the market will probably test how much the yield curve can bull flatten," the trader said.
The benchmark 10-year JGB yield, which settled at 0.910 percent on Tuesday, hit a seven-year low of 0.820 percent. The 10-year yield later pulled up from that trough to stand at 0.835 percent JP10YTN=JBTC, down 7.5 basis points on the day.
That still left 10-year JGBs with a yield more than four times the five-year JGB yield, which fell 2 basis points to 0.200 percent JP5YTN=JBTC, also the lowest in seven years.
Lead December 10-year JGB futures climbed 0.48 point to 144.15 2JGBv1 and hit a seven-year peak of 144.31.
Market players said the rally in 10-year JGBs was exacerbated by short-covering by bond dealers who had shorted the benchmark 310th issue, looking to cover their positions at a 10-year bond auction on Thursday.
But because the 10-year JGB yield has fallen sharply in the past two sessions it is now unlikely that the new 10-year debt will be offered as a re-opening of the 310th bond.
As a result, dealers scrambled to borrow the issue in the repo market to cover their short positions, making the 310th issue expensive in that market and contributing to its richness on the yield curve, market players said.
Superlong JGBs underperformed compared to 10-year bonds with the 20-year yield dipping by a comparatively mild 4 basis points to 1.635 percent JP20YTN=JBTC.
The 10-year/20-year yield spread widened to 80 basis points, nearing a six-month high of 82.5 basis points touched in mid-September.
Some market players say superlong bonds may fare worse compared to shorter maturities, partly because the BOJ's policy has reflationary and inflation-targeting like characteristics.
In addition, memories of the sharp sell-off in superlong JGBs in late August are still fresh in investors' minds.
"I get the sense that superlong bonds may be a bit hard to buy until market volatility subsides, because of the impact from the jump in their yields seen from late August," said a fund manager at Schroder Investment Management.
Some market players said the bull flattening of the JGB yield curve may eventually stretch out towards the superlong sector.
Kazuhiko Sano, fixed income strategist at Tokai Tokyo Securities, said that while the BOJ's measures can be interpreted as being reflationary, the yield curve may still flatten in coming months.
"I think what will happen is that market players will push the five-year yield lower initially, and after that we might see a bull-flattening," Sano said, adding that investors may pick up 10-year and 20-year bonds in search of capital gains.
"I can understand how this can be seen as a reflationary policy, but there aren't many options in terms of assets that can be bought," he said.
For example, the size of Japan's real estate investment trust market is likely only several trillions of yen, meaning there is limited scope for the BOJ to buy such assets, Sano said.
BOJ Governor Masaaki Shirakawa said on Tuesday the BOJ may expand the size of its asset buying pool if the need arises in the future.
In the money market, overnight call money was traded near 0.075 percent to 0.08 percent JPONMU=TKTN earlier on Wednesday.
The rate dipped from the previous day due to the BOJ's decision to trim the overnight call rate target, a trader for a Japanese money broker said.
The BOJ lowered its policy target for the overnight call rate to a range of around zero to 0.1 percent, from its previous target of 0.1 percent.
But the BOJ kept unchanged the 0.1 percent interest rate that it pays on banks' excess reserves, meaning financial institutions can earn that much by parking money at the BOJ and giving them little incentive to lend in the money market below that level.
That is seen as likely to help limit falls in the overnight call rate, even if the BOJ ramps up its fund injections. (Additional reporting by Takefumi Ito and Hideyuki Sano, Takahiro Okamoto at IFR; Editing by Joseph Radford)