Japan’s Bonds Gain for 2nd Week on Outlook for Rates, Deflation

Nov. 21 (Bloomberg) -- Japan’s 20-year government bonds gained for a second week after the central bank held interest rates near zero amid mounting pressure for it to fight deflation.

Benchmark 20-year yields were near the lowest level in more than a month after central bank Governor Masaaki Shirakawa and his colleagues kept the benchmark overnight rate at 0.1 percent in a unanimous vote yesterday. The world’s second-largest economy is in deflation for the first time in three years, the Cabinet Office said in a monthly report.

“There’s no chance for the central bank to raise rates in the foreseeable future,” said Koji Ochiai, a senior market economist in Tokyo at Mizuho Investors Securities Co., a unit of Japan’s second-largest lender. “The bank is pressured to expand monetary easing measures and buy more bonds.”

Twenty-year bond yields declined six basis points during the week to 2.04 percent at Japan Bond Trading Co., the nation’s largest interdealer debt broker. Yields touched 2.025 percent, the lowest since Oct. 13. They completed a seven-day drop on Nov. 19, the longest slide since a 12-day decline ended Dec. 30.

Ten-year yields fell 3.5 basis points to 1.305 percent this week, while five-year yields slipped three basis points to 0.59 percent. Both held near their lowest levels in more than a month.

Bond futures for December delivery advanced 0.37 this week to 139.25 on the Tokyo Stock Exchange.

Fighting Deflation

“Japan’s economy is in a mild deflationary phase,” the Cabinet Office report said in Tokyo yesterday, referring to prices in its evaluation for the first time since June 2006. The economy is “in a difficult situation,” the report said.

The BOJ can buy more bonds to help combat deflation as the purchases would provide more liquidity and push up price expectations, Angel Gurria, secretary general of the Organization for Economic Cooperation, said in Tokyo on Nov. 19.

The spread between rates on five-year notes and inflation- linked debt, which reflects the outlook among traders for consumer prices over the term of the securities, was negative 0.88 percentage point yesterday, from minus 0.82 on Nov. 18.

Inflation-adjusted securities typically yield less than regular bonds because their principal payment increases at the same rate as inflation. Deflation, a general drop in prices, enhances the value of the fixed payments from bonds.

Consumer prices excluding fresh food dropped for a seventh month in September and the central bank said last month it expects them to keep sliding through fiscal 2011.

Yen, Stocks

“The BOJ won’t raise interest rates until 2012,” which should help bonds, said Eiji Dohke, chief strategist in Tokyo at UBS Securities Japan Ltd., one of the 23 primary dealers that are required to bid at government debt sales.

Twenty-year bonds also gained as the yen approached the strongest level in more than a month versus the dollar, damping the outlook for exporters’ profits.

Japan’s currency traded at 88.84 yen per dollar yesterday from 88.97 in New York on Nov. 19, when it climbed to 88.64, the strongest since Oct. 9. The Nikkei 225 Stock Average fell 0.5 percent yesterday, completing a four-week drop.

“Given the yen appreciation and the decline in stocks, investors cannot help but to buy bonds,” said Makoto Yamashita, chief Japan interest-rate strategist at Deutsche Securities Inc. in Tokyo. “Also month-end demand from pension funds can be expected as they seek to extend duration.” Duration is a gauge of how much a change in yield affects a bond’s price.

Nomura Securities Co. increased the average duration of its Bond Performance Index by 0.07 year to 6.41 years this month, according to the company’s Web site. Duration for December will be posted on the Web site toward the end of the month.

Money managers such as Japan’s Government Pension Investment Fund, which runs the world’s largest pool of retirement wealth, use the index to help decide their holdings.