Nov. 11 (Bloomberg) -- Japanese government bonds may rise for a second day, the first back-to-back gain in a month, as yields near the highest level since June attract investors.

Demand for bonds is likely to increase before a Bank of Japan report tomorrow that economists forecast will show producer prices dropped in October. Deflation enhances the value of the fixed payments on debt. Reports yesterday showed the current-account surplus widened in September and merchant sentiment tumbled to a five-month low. Cabinet Office data released today showed machinery orders surged in September.

“There should be a lot of demand for bonds with yields around 1.485 percent,” said Kazuhiko Sano, chief strategist in Tokyo at Citigroup Global Markets Japan Inc., one of the primary dealers that are obliged to bid at government debt sales. “The yield curve will probably steepen slightly.”

Ten-year bond futures for December delivery rose 0.06 to 137.61 as of 9:01 a.m. at the Tokyo Stock Exchange.

The benchmark 10-year bond hasn’t traded yet today at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The yield on the 1.4 percent bond due in September 2019 fell half a basis point to 1.47 percent yesterday, when it touched 1.485 percent, the highest since June 16. Ten-year yields may decline to 1.455 percent today.

Machinery orders, an indicator of business investment in three to six months, climbed 10.5 percent from August, when they rose 0.5 percent, the Cabinet Office said today in Tokyo. Economists in a Bloomberg survey expected an increase of 4.1 percent.

Real Yields

“Japan has been in deflation, remains in deflation,” Robert Feldman, head of Japan economic research at Morgan Stanley in Tokyo, said in a Bloomberg Radio interview yesterday.

Producer prices dropped 6 percent in October after tumbling 7.9 percent the prior month, according to the median estimate of economists in a Bloomberg News survey. Consumer prices fell 2.3 percent in September.

So-called real yields, or what investors get after accounting for the cost of living, are near the highest since 1995. Real yields climbed to about 3.8 percent, the highest since 1995, according to data compiled by Bloomberg.

“The recovery process for Japan in 2010 is expected to be modest and fragile, since domestic economic conditions point towards a possibly extended period of deflation,” David Riley, head of global sovereign ratings at Fitch Ratings, said in a statement released in Tokyo yesterday.

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

Last Updated: November 10, 2009 19:21 EST