Bonds News

JGBs surge, BOJ tankan adds to easing prospects

* Dour tankan outlook adds to prospects of further BOJ easing

* BOJ could ease in October by expanding fund supply tool

* But BOJ seen saving bond buying option for later

TOKYO, Sept 29 (Reuters) - Japanese government bonds extended gains on Wednesday, with futures hitting a seven-year high, after a dour outlook in a key business sentiment survey added to prospects of more monetary easing, including a possible expansion of a fund supply tool and a boost in bond purchases.

The BOJ’s quarterly tankan survey of business sentiment showed big manufacturers’ confidence continued improving in September but they were cautious about the outlook in a sign that yen strength could derail the fragile economic recovery. [ID:nTOE68S009] [ID:nTOE68R02Y]

“Seen overall, the tankan points to more easing and is supportive to the debt market,” said Takeo Okuhara, a fund manager at Daiwa SB Asset Management.

“The central bank has to keep supporting corporate activity as capital spending and employment conditions remain weak in spite of improved access to funds.”

The BOJ meets on Oct. 4-5 and expectations for more easing steps have already been increasing as a result of the yen’s rise. If it were to ease, an expansion of a cheap fund-supply tool and a boost in its bond-buying are seen as the most likely options.

An expansion in the fund supply tool would likely nudge down mainly money market and short-end debt yields, although analysts say the impact would likely be limited with rates already at very low levels.

A boost in its bond buying, known as rinban, would likely have a more significant impact and flatten the yield curve as the BOJ’s operation targets JGB maturities across the board.

But the BOJ is expected to be more cautious about the rinban option as it could lead to criticism that it is monetising debt of a country that has public debt twice the size of its $5 trillion economy.

Sources also say some BOJ officials want the central bank to save its dwindling arsenal of policy options in case the economy deteriorates further. [ID:nSGE68Q0KS]

“The likelihood of BOJ easing at the next meeting in October is increasing although it is not expected to immediately opt for a rinban increase,” said RuiXue Xu, a rates strategist at RBS Securities.

“If the Fed takes some kind of action in November, that would pave the way for a rinban increase. It is still unclear at this stage how it would go about increasing its bond buying but it may try to keep the purchases spread out so it does not distort the yield curve,” she said.

The BOJ last boosted its bond buying amount in March 2009, raising purchases to 21.6 trillion yen a year from 16.8 trillion yen per year, an increase of roughly 29 percent.

It raised its buying of bonds with maturities of less than one year by 35 percent; those above one year and up to 10 years by 25 percent; and those above 10 years and up to 30 years by 33 percent.

“If the BOJ were to up the rinban amount -- a scenario we don’t envisage until around December -- it is likely to keep the increase proportionate with the amount it buys in each maturity group,” said Naomi Hasegawa, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities.

The yield curve flattened as month-end duration extensions by index-following investors pushed down longer-dated yields which have been declining on increased prospects of the BOJ boosting bonds purchases down the road.

The five-year/20-year yield spread tightened to a one-month low below 140 basis points.

But a repeat of the bull flattening seen in August, when the spread hit a 15-month low of around 125 basis points, could be hampered as the market’s focus turns to supply in the upcoming quarter as Japan’s cash-strapped government begins to look for ways to fund next fiscal year’s budget.

The five-year yield JP5YTN=JBTC dipped 0.5 basis point to 0.265 percent.

The benchmark 10-year yield JP10YTN=JBTC dropped 4 basis points to a one-month low of 0.920 percent, declining about 15 basis points this quarter.

The 20-year yield JP20YTN=JBTC fell 4 basis points to 1.650 percent, pulling further away from a three-month peak of 1.975 percent hit in mid-September when a ruling party leadership vote in Japan sparked supply concerns.

December 10-year JGB futures 2JGBv1 gained 0.35 point to 143.30 after hitting 143.40, the highest since June 2003. Futures gained 1.74 points on the quarter for a second straight quarter of gains. (Editing by Joseph Radford)