JGBs pressured as BOJ rate rise forecasts heat up

TOKYO, June 21 (Reuters) Japanese government bond (JGB) prices fell on Wednesday, with 10-year futures sliding to a five-week low on growing expectations the Bank of Japan will raise interest rates as early as next month.

BOJ Governor Toshihiko Fukui suggested on Tuesday the central bank was on course to raise interest rates in coming months, saying that policy decisions should be taken ''early'' if warranted by economic conditions.

JGB futures trimmed some losses by the end of the morning session, but analysts said that increased anticipation of a rate rise was steering the market lower after weeks of directionless trading.

''The JGB market is entering a downtrend, with the short- to medium-term sectors weighed down significantly by expectations for a BOJ rate increase in July,'' said Hiroyuki Kubota, a bond analyst at Fisco.

Banks are major buyers of the short- to midterm sectors, which are sensitive to rising interest rates.

The lead September futures contract ended the morning session 0.12 point lower at 132.21, recovering after tumbling to 132.03 earlier in the session, the lowest level for a lead futures contract since mid-May.

The two-year yield rose 2.5 basis points to 0.825 percent and the five-year yield gained three basis points to 1.370 percent.

The benchmark 10-year bond yield was up 1.5 basis points at 1.865 percent, shrinking the spread between two- and 10-year notes to 104 basis points from 105 basis points on Tuesday.

UPBEAT OUTLOOK A government survey released before the market opened supported the BOJ's bullish economic outlook, traders said.

Big Japanese manufacturers were slightly less confident about business conditions in the three months to June compared with the previous quarter, but manufacturers forecast a huge improvement in the sentiment index for the July-September quarter.

Companies also said they expected capital spending to rise 8.8 percent this fiscal year from last year and forecast recurring profits to rise 6.7 percent from last business year.

Analysts said the data suggested that the BOJ's quarterly tankan survey of business sentiment due on July 3 could show that firms are becoming more confident about the economy, which could set the stage for an early rate rise.

Traders will also be on the lookout for Japanese consumer prices data due on June 30 to gauge the probability of a rate increase at the BOJ's July 13-14 policy meeting.

If the data underscores the central bank's positive outlook on the economy and prices, traders said chances will rise for the BOJ to raise rates in July for the first time in six years.

Some analysts said that in addition to the tankan, a solid recovery in Japanese stock prices would be key to whether the central bank can tighten credit next month.

A rise in the Nikkei stocks average to above 16,000 by the beginning of July following its 20 percent dive in the past two months, would also crucial to justify higher rates, said Masuhisa Kobayashi, chief JGB strategist at Barclays Capital.

In addition, next month's tankan must show a rise in forecasts for capital investment growth in the financial year of more than 5.4 percent to bolster the case for a July rate rise, he wrote in a research note.

The key December euroyen interest rate futures were down 0.015 to 99.330 after falling to 99.310, indicating a three-month interbank rate of 0.69 percent by that time.

Such investors as life insurers and pension funds were showing interest in buying longer maturities as their yields rose, paving the way for a bear curve flattening, traders said.

There had been some speculation in the market that the drop in the Nikkei share average and Fukui's investment in a fund whose manager has been arrested for suspected insider trading could delay the BOJ's decision to raise rates.

Traders said they would be eyeing the Ministry of Finance's weekly auction of three-month financing bills this session.

If the highest accepted yield at Wednesday's sale was around the level of last week's three-month FB offer, which was 0.343 percent, it would indicate that market expectations remain firmly in place for a BOJ rate rise as early as next month, they said.

REUTERS SY VC0910