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* Market players test how flexible BOJ will be under new policy
* 10-year yield rises to 0.115 pct, highest since early 2017
By Hideyuki Sano
TOKYO, Aug 1 (Reuters) - Japanese bond yields soared to a 1-1/2 year high on Wednesday, reversing the sharp falls of the previous day, as market participants put the central bank’s commitment to allow yields to move more flexibly to the test.
The benchmark 10-year Japanese government bond yield jumped 7.0 basis points to 0.115 percent, hitting the highest since February 2017.
“I would think the 10-year yield will in the end settle around or below 0.15 percent, although there could be occasions where the yield may test 0.20 percent,” said Koichi Sugisaki, a strategist at Morgan Stanley.
Bank of Japan Governor Haruhiko Kuroda said on Tuesday the central bank would tolerate moves in the 10-year JGB yield of around 20 basis points from its policy target of zero percent, wider than the range of 10 basis points around the target allowed previously.
His comments cleared initial market uncertainty on what exactly the BOJ meant by granting greater flexibility for yield moves.
Traders quickly took the opportunity to test their new-found freedom by selling JGBs, which have long been propped up — and controlled — by the BOJ’s massive buying programme.
The 10-year JGB futures fell 0.76 of a point, trading in their widest daily range since the BOJ introduced the current “yield curve control” policy, under which it aims to control not just short-term interest rates but also the 10-year bond yield.
The success of the BOJ’s efforts to control the 10-year yields means there have been days in recent months when the benchmark 10-year JGB was not traded at all, part of the central bank’s reason for allowing more flexible trading.
The market had initially jumped after the BOJ’s announcement on Tuesday because the BOJ surprised market players by pledging to keep rates at current low levels for an extended period of time.
The BOJ even made a reference in a statement to uncertainties stemming from a planned tax hike in October 2019, leading many to speculate low rates will stay at least until then.
Many traders had to cover big short positions they made before the policy announcement, anticipating some relaxation of its control on the bond yield.
The five-year yield rose 4.5 basis points to one-year high of minus 0.055 percent and the two-year yield rose to 13-month highs of minus 0.090 percent.
Following the spike in market volatility, Japan Securities Clearing Corp triggered an emergency margin call, though traders said that the impact on the market would be limited.
The Japanese yen remained under pressure after the BOJ promised to keep rates low for an extended period of time, putting the central bank at odds with those of other economies that are looking to raise interest rates.
Japanese shares rose 1.0 percent on Wednesday thanks mainly to positive earnings and as the BOJ did not change its ETF buying target of six trillion yen a year. (Reporting by Tokyo Markets Team Editing by Shri Navaratnam and Sam Holmes)