March 26 (Bloomberg) -- Japan’s five-year notes fell for a third day, the longest losing streak in two months, after a failed U.K. gilt auction raised concern the flood of government debt sales worldwide is overwhelming demand.

Ten-year Japanese yields climbed to the highest in a week after the U.K. didn’t find enough buyers at yesterday’s sale. U.S. yields rose at yesterday’s $34 billion auction of five-year notes even as the Federal Reserve started to buy longer-term debt to keep borrowing costs down. Japanese bonds last week rose the most in more than a month as the Bank of Japan said it will purchase more government securities.

“There are supply concerns smothering global bond markets and it’s offsetting central bank efforts of buying bonds,” said Takashi Nishimura, an analyst in Tokyo at Mitsubishi UFJ Securities Co., a unit of Japan’s largest bank by assets. “Last week the Japanese bond market was optimistic about central bank bond purchases, but now the market is returning to the reality of supply.”

The yield on the 0.8 percent note due March 2014 rose 2.5 basis points to 0.77 percent as of 4:23 p.m. in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price fell 0.12 yen to 100.143 yen. A basis point is 0.01 percentage point.

Ten-year yields increased 2.5 basis points to 1.31 percent after reaching 1.315 percent, the highest since March 17. Ten- year bond futures for June delivery declined 0.55 to 138.48 at the afternoon close on the Tokyo Stock Exchange.

Quarterly Loss

Japanese bonds are headed for the biggest first-quarter loss in three years and Treasuries are set for their worst start to the year since 1996 as the governments of the world’s two biggest economies expand debt sales to fund attempts to pull their nations out of recession.

Ten-year U.K. gilt yields climbed as much as 20 basis points to 3.53 percent after yesterday’s sale received bids for less than the amount of bonds offered. U.K. Prime Minister Gordon Brown aims to sell a record 146.4 billion pounds ($214 billion) of debt this fiscal year to fund plans aimed at lifting Europe’s second-largest economy out of a recession.

“The rise in Treasury yields despite the Federal Reserve’s efforts and the failure of the U.K. sale is reverberating across debt markets,” said Kazuhiko Sano, chief strategist in Tokyo at Nikko Citigroup Ltd. “Bonds will continue to decline given the further deteriorating conditions for debt.”

Ten-year U.S. Treasury yields rose three basis points today to 2.82 percent. They added nine basis points yesterday, expanding the yield advantage over similar-dated Japanese debt to 1.5 percentage points, the widest in a week, according to data compiled by Bloomberg. The spread between 10-year U.K. gilts and Japanese bonds was 1.99 percentage points.

Expanding Gap

The difference in yields between Japanese and U.S. debt is likely to increase to 1.64 percentage points by the end of September, according to a Bloomberg News survey of economists and analysts. The estimate puts a heavier weighting on more recent forecasts. The spread between Japanese and U.K. bonds will expand to 2.06 percentage points in the same period, the survey showed.

Investors in Japanese debt lost 0.4 percent since Dec. 31, the worst start to the year since a 1.3 percent decline in 2006, as the government said it will boost debt sales by 7 trillion yen ($71.3 billion) to 113.3 trillion yen next fiscal year. Treasuries slid 2.2 percent in the same period, according to indexes compiled by Merrill Lynch & Co.

Japanese 10-year bond yields fell six basis points last week after the Bank of Japan said March 18 it will raise monthly debt purchases to 1.8 trillion yen from 1.4 trillion yen. The Fed also said it will buy Treasuries.

Zero Inflation

The decline in bonds was limited before a government report tomorrow that economists estimate will show the inflation rate held at zero in February, underpinning the attraction of fixed- income securities.

Consumer prices excluding fresh food were unchanged from a year earlier, according to the median estimate of economists surveyed by Bloomberg. Prices last increased in December. Japan will experience a general drop in prices, known as deflation, through the first quarter of next year, according to a separate Bloomberg survey.

Inflation-linked bonds signal the world’s second-largest economy may enter deflation. Ten-year bonds protected against inflation yield about 2.01 percentage points more than similar- dated conventional bonds, Bloomberg data show. The securities typically yield less than regular bonds because their principal payment increases at the same rate as inflation.

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

Last Updated: March 26, 2009 03:44 EDT