JGBs down on Nikkei gains before data deluge

TOKYO, Sept 27 (Reuters) Japanese government bonds retreated on Thursday, with 10-year futures falling back towards a five-week low on a solid rise in Tokyo shares as investors awaited a slew of data in the next few days.

Activity was tepid as portfolio managers prepare to close their books on the first half of the fiscal year this week while bracing for the reports on consumer prices and employment on Friday as well as the September tankan survey on Monday.

A 1.7 trillion yen (.7 billion) auction of two-year notes was not expected to cause dealers much indigestion. The offer came with a 0.9 percent coupon, matching that in the previous month's auction.

Bank of Japan board member Miyako Suda said in a speech to regional business leaders that low interest rates could lead to an overheating of the economy and it is desirable to act gradually and reasonably early on rates.

Suda, known as a policymaker eager to normalise policy, said the problems in the U.S. housing market could last longer than previously thought but said a U.S. economic slowdown was unlikely to have a big impact on Japanese exports.

''These comments may mean we may not have to give up expectations for a December rate hike,'' said Tomoko Fujii, senior economist and strategist at Bank of America.

Suda also gives a press conference at 0430 GMT.

The BOJ has held rates at 0.5 percent for the past seven months even while repeating that it expects the economy to sustain its moderate expansion.

December 10-year futures fell 0.17 point to 134.66 back near a five-week low of 134.44 struck last Friday.

The benchmark 10-year yield climbed 3 basis points to 1.695 percent, near a five-week high of 1.700 percent reached last week.

The five-year yield was up 2 basis points at 1.235 percent, while the two-year yield rose 1.5 basis points to 0.875 percent.

Twenty-year bond yields rose 2.5 basis points to 2.195 percent, with the maturity giving up some of its hefty gains of the past two days on buying before month-end and fiscal half-year end.

Market players are looking for clues on how well the economy is holding up in the face of the U.S. slowdown and credit troubles that prompted the Federal Reserve to slash interest rates by a half-point last week.

Any signs of resilience in the economy could convince more investors the BOJ could raise rates in coming months, with swap contracts on the overnight call rate showing a roughly 50 percent chance of a rate hike in December.

''The tankan is very important for rate hike expectations in the fourth quarter,'' said Makoto Yamashita, chief JGB strategist at Lehman Brothers.

Yamashita said the revisions to the capital spending figures in the tankan survey would be important for the potential timing of a BOJ rate hike, but the tankan could be overshadowed by U.S. economic data next week including the monthly payrolls report.

The tankan's headline diffusion index of confidence at big manufacturers is forecast to dip slightly, while capital spending in the current business year is seen being downgraded to a rise of 7.5 percent from 7.7 percent in the June survey.

''Many investors have no confidence in their outlook for yields.

It basically depends on the U.S. economic deterioration,'' Yamashita said.

Analysts have said that depending on the outcome of the coming figures, a wave of money could come back into the JGB market as the second half of the business year kicks off next week.

In the stock market, the Nikkei share average rose 1.5 percent to a six-week intraday peak of 16,696 following gains on Wall Street overnight and a weaker yen.

REUTERS PBB PM1201