Japanese Bonds Complete Biggest Gain in a Week on ECB Comments

By Theresa Barraclough

July 5 (Bloomberg) -- Japan's bonds advanced yesterday after European Central Bank President Jean-Claude Trichet's comments eased speculation the Bank of Japan will increase borrowing costs this year.

Benchmark debt yesterday completed its biggest gain in a week after Trichet on July 3 said he isn't ``pre-committed'' to lifting interest rates to combat inflation, after the central bank boosted borrowing costs for the first time in a year. Bonds also gained on a report that showed U.S. employers cut jobs for the sixth consecutive month in June.

``The Bank of Japan is now under less pressure for a coordinated effort by central banks,'' said Takashi Nishimura, an analyst at Mitsubishi UFJ Securities Co. in Tokyo. ``Investors are focusing more on fundamentals.''

The yield on 10-year securities auctioned on June 3 with a 1.7 percent coupon fell 3 basis points yesterday, the biggest decline since June 27, to 1.64 percent in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. A basis point is 0.01 percentage point.

Ten-year yields may decline to as low as 1.55 percent by the end of September, Nishimura said. Should his predictions prove accurate, investors would stand to make a 1.1 percent return, according to Bloomberg calculations.

Ten-year bond futures for September delivery yesterday rose 0.32 to 135.18 as of the afternoon close at the Tokyo Stock Exchange.

Weekly Decline

Bonds completed a weekly decline on speculation a government report on July 10 will show wholesale prices rose last month. Ten-year yields added 3 basis points this week.

``Inflation remains a concern in the long run,'' said Tatsuo Ichikawa, a fixed-income strategist at ABN Amro Securities Japan Ltd. in Tokyo. ``Inflation-linked bonds are a good investment. It has limited downside.''

Japan's producer-price inflation accelerated to 5.3 percent in June from 4.7 percent in May, according to the median estimate of 26 economists surveyed by Bloomberg News.

Consumer prices, excluding fresh food, rose 1.5 percent in May from a year earlier, the statistics bureau said in Tokyo on June 27. Crude oil for August delivery rose to a record $145.85 a barrel yesterday. Accelerating inflation reduces the value of the fixed interest debt pays.

The extra yield paid by 10-year conventional government debt compared with similar-maturity inflation-linked bonds was about 59 basis points yesterday from 46 basis points a week ago, according to data compiled by Bloomberg.

The so-called breakeven inflation rate reflects investors' expectations for average annual increases in consumer prices over the next decade.

Bunds Versus JGBs

German two-year bunds on July 3 rallied the most in 3 1/2 months after Trichet's comments, dropping about 19 basis points to 4.45 percent. The spread between two-year German and Japanese yields shrunk to about 3.60 percentage points that day, the narrowest since June 12, according Bloomberg data.

``Japan's yield curve will be under pressure to steepen,'' Mitsubishi UFJ's Nishimura said. A yield curve is a chart that plots the yields of bonds with different maturities.

The difference in yields between two- and 10-year debt was about 80 basis points yesterday, compared with 77 basis points three months ago, according to data compiled by Bloomberg. The spread will probably widen to 83 basis points by September, according to a Bloomberg News survey of economists and analysts. The estimate puts a heavier weighting on more recent forecasts.

There was a 27 percent chance yesterday the Bank of Japan will raise its target rate by a quarter-percentage point to 0.75 percent by Dec. 31, according to calculations by JPMorgan Chase & Co., using overnight interest-rate swaps. The odds were 31 percent on July 3 and as high as 92 percent on June 11.

U.S. employers cut 62,000 jobs in June, the Labor Department said on June 3, larger than a 60,000 drop estimated by economists. The U.S. is Japan's largest export market.

To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.