November 28, 2014 / 9:50 AM / 4 years ago

UPDATE 2-Japan bond yield turns negative as BOJ purchases slash supply

* Two-year JGB traded at yield of minus 0.005 pct

* BOJ’s massive bond purchase crushing debt yields

* Negative yields may spread to longer maturities in long run (Adds BOJ’s tweak in operation, analyst comments, bullets)

By Hideyuki Sano

TOKYO, Nov 28 (Reuters) - Japanese government bond yields on Friday turned negative for the first time as the Bank of Japan’s massive asset-purchase scheme aimed at boosting inflation and reviving the economy led to a severe shortage of bonds in the market.

The yield on two-year JGBs traded at minus 0.005 percent . Negative yields may spread to longer maturities if the central bank buys more debt, traders said.

The BOJ may need to step up its stimulus and soak up more debt paper after global oil prices plunged this week and made its inflation goal harder to reach.

While negative yields are unusual, they are not uncommon. Record low interest rates in Europe have seen yields in Germany and Switzerland turn negative, prompting European investors to seek higher-yielding debt elsewhere.

“Foreign investors, particularly European buyers, are seeing supply of debt at home tighten continuously,” said Makoto Noji, senior fixed-income strategist at SMBC Nikko Securities. “They can opt to buy JGBs, with short-term euro zone yields already in the negative.”

Traders said Friday’s JGB milestone is largely a side-effect of the BOJ’s resolve to spark credit growth and get the wheels of commerce turning via its “quantitative and qualitative” easing.

The central bank last month stunned markets by expanding its monetary easing programme, just weeks before data showed the world’s third-biggest economy had unexpectedly slipped back into recession in the third quarter.

Now, the drop in oil prices raises fresh complications for the BOJ, which has pledged to lift inflation to its 2 percent target by the next fiscal year.

Oil sank more than 6 percent on Thursday following OPEC’s decision not to cut output, and is down more than 35 percent from their peak in June, looking set to bring down Japan’s consumer price inflation in coming months.

“Japan’s core consumer price is likely to fall to around 0.5 percent by March,” said Junichi Makino, chief economist at SMBC Nikko Securities.

Makino was referring to the core CPI excluding the impact of a sales tax hike in April, which the BOJ is tracking closely. Data published on Friday showed core inflation stripping out the tax effect at around 0.9 percent.

“The BOJ will likely be forced to take additional easing steps by April,” Makino said.

Traders say the two-year yield is likely to return to positive in the near term as the BOJ said after the market close on Friday that it will scale back buying of short-term bonds for now.

The move is seen as fine-tuning of its operation to bring the average maturity of its bond buying in line with the policy mandate of seven to 10 years.

Still, many market players expect negative yields could gradually spread to longer maturities as in some European countries in the long run.

In Germany, three-year bonds are traded below zero, and in Switzerland, even five-year bonds are trading at negative yields. (Additional reporting by Shinichi Saoshiro and Yoshifumi Takemoto; Editing by Shri Navaratnam and Ryan Woo)

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