JGBs rise on Treasuries, end-month buying

TOKYO, Aug 31 (Reuters) Japanese government bonds rose on Friday, supported by a rally in U.S. Treasuries the previous day and end-month buying, as well as continuing short covering after a strong two-year note auction.

Market reaction to Japanese data released earlier in the session was limited as the figures were generally in line with expectations.

Cautious remarks on Thursday by Bank of Japan board member Atsushi Mizuno, a well-known policy hawk, have also kept sentiment solid for JGBs investors, analysts said.

''Market sentiment is solid,'' said Naomi Hasegawa, a senior fixed income strategist at Mitsubishi UFJ Securities. ''U.S.

Treasuries rose, the two-year auction drew very strong demand, and some players took Mizuno's comments as surprisingly cautious.'' Reallocation needs from large bond redemptions next month and the month-end duration extension of main benchmark indexes such as the Nomura BPI were also behind buying, traders said.

September 10-year futures rose 0.13 point to 135.94, moving towards an 18-month high of 136.46 hit last week.

The benchmark 10-year yield fell 2.5 basis points to 1.540 percent, an 18-month low hit last week, the lowest since before the BOJ ended its super-loose quantitative easing policy in March last year.

The five-year yield eased 1 basis point to 1.110 percent, near an 11-month low of 1.080 percent hit last week.

The two-year yield also fell 1 basis point to 0.835 percent, closing in on a four-month low of 0.810 percent hit two weeks ago.

The two-year JGB auction on Thursday drew strong demand despite a low coupon, reflecting investor preference for safety in government bonds as the recent upheaval in overseas credit and money markets sours risk appetite.

JGB yields have touched multi-month lows over the past couple of weeks as concerns about worsening credit markets prompted investors to flee stocks for bonds, and raised doubts about an interest rate hike by the Bank of Japan as early as next month.

BOJ's Mizuno said on Thursday a cut in U.S. rates would change the basis of debate as central banks wonder how gyrating markets will affect the world economy.

Mizuno later said a rate cut by the Federal Reserve at its Sept. 18 meeting would not necessarily prevent a rate hike by the BOJ the following day.

Swap contracts on the overnight call rate show investors see around a 20 percent chance of a BOJ rate hike in September and a near 40 percent chance of a hike in October.

Data showed Japanese core consumer prices fell 0.1 percent in July, as widely expected, while Tokyo core price data for August was flat, slightly firmer than anticipated.

Japan's jobless rate stood at 3.6 percent in July, a nine-year low, suggesting that tighter job conditions will eventually push up prices as forecast by the BOJ.

Japan's industrial production fell 0.4 percent in July from a month earlier, compared with a 0.5 percent drop expected.

Reuters RKM VP0708