Sept. 22 (Bloomberg) -- Japanese government bonds completed their biggest weekly slide in more than three months on speculation investors will demand higher yields to compensate for the risk that global inflation will pick up.

The Federal Reserve's unexpected half-percentage-point cut this week in interest rates and record crude oil prices fueled concerns inflation will accelerate, pushing down U.S. Treasuries. Japan's so-called yield curve steepened as the spread in yields between two- and 10-year debt reached its widest since July.

``The Fed's large rate cut while oil and commodity prices are rising has fueled concerns over inflation and set the trend for a steeper yield curve globally,'' said Nobuto Yamazaki, who helps oversee the equivalent of about $6.1 billion in mutual funds at DLIBJ Asset Management Co. in Tokyo.

The yield on the benchmark 10-year bond rose 12.5 basis points to 1.68 percent this week at Japan Bond Trading Co., the nation's largest interdealer debt broker. The increase was the biggest since the week ended on June 8. Yields move inversely to prices and a basis point is 0.01 percentage point.

Ten-year bond futures for December delivery declined 1.27 to 134.70 this week in Tokyo.

Bonds also fell after Bank of Japan Governor Toshihiko Fukui reiterated the need to raise rates after keeping them unchanged at the end of its two-day meeting on Sept. 19.

The head of the central bank told reporters in Tokyo that policy makers are aware of the risk of keeping the benchmark rate at its current ``very low'' level.

Rate Outlook

Fukui cited the yen carry trade, where investors borrow money in Japan to purchase higher-yielding assets outside the country, as an example of how resources can be misallocated as a result of cheap credit.

``Fukui's comments showed he hasn't given up a rate hike'' this year, DLIBJ Asset's Yamazaki said. ``That also contributed to push up yields.''

Bonds in Japan and the U.S. often move in the same direction. Yields on Japanese and U.S. 10-year bonds had a correlation of 0.91 this year, according to data compiled by Bloomberg. A value of 1 would mean they moved in lock step.

Japan's bonds completed a three-day slide yesterday after U.S. 10-year notes fell the most since June the previous day.

``The theme of the global bond market has changed to inflation concerns from a flight to quality on the subprime shock,'' said Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Securities Co. in Tokyo, the top-ranked bond analyst in Japan according to Nikkei Bonds and Financial Weekly. ``The plunge in U.S. Treasuries may push down Japanese bonds.''

In Japan, the spread between two- and 10-year yields widened to about 84 basis points yesterday, the most since July, according to data compiled by Bloomberg.

Subprime Concerns Linger

The Nikkei 225 Stock Average slid 0.6 percent yesterday, halting a two-day gain, paced by declines in exporters relying on the U.S. economy such as Toyota Motor Corp. Fed Chairman Ben S. Bernanke on Sept. 20 said the sell-off in credit markets could make the housing recession more severe.

``It will take time until the consequences of the subprime problem settle and clouds over the economy are wiped out,'' said Jun Fukashiro, a Tokyo-based bond fund manager at Toyota Asset Management Co. which holds the equivalent of about $10.4 billion in assets. ``Given the prospects that yields may trade between 1.5 percent and 1.8 percent by the end of March, some investors may start picking up bonds with yields above 1.7 percent.''

Ten-year yields rose as high as 1.7 percent yesterday, a level unseen since Aug. 14.

Three-Day Weekend

Yields may be too low to attract investors as they prepare to allocate assets for the second half of the fiscal year that began in April, according to Akihiko Inoue, market analyst at Mizuho Investors Securities Co. in Tokyo. Demand for bonds may be limited because financial markets will be closed on Sept. 24 for a national holiday, he added.

Benchmark 10-year yields have fallen from an almost one- year high of 1.985 percent on June 13.

Yields ``will adjust until they reach a level that attracts buying for the new period,'' said Inoue, whose company is one of the 25 primary dealers that are required to bid at auctions.

Ten-year yields may rise to 1.82 percent by the end of December, according to the weighted average forecast of a Bloomberg News survey of economists and analysts. The estimate puts a heavier weighting on more recent forecasts.

To contact the reporter on this story: Keiko Ujikane in Tokyo at kujikane@bloomberg.net

Last Updated: September 21, 2007 18:51 EDT