Nov. 14 (Bloomberg) -- Japan's five-year notes rose for a second day as speculation the global economic slump is deepening boosted demand for government debt.

The securities extended the week's gain before a government report Nov. 17 that may show the world's second-largest economy barely expanded in the third quarter. Demand for shorter-maturity notes also increased on optimism the Bank of Japan will add more money into the financial system, lowering money-market rates.

``The market is expecting short-term money rates to fall next week, so it's a signal for investors to start buying,'' said Tokyo-based Takashi Nishimura, an analyst at Mitsubishi UFJ Securities Co., a unit of Japan's largest bank by assets. Should GDP come out much worse, ``it'll be a very positive surprise for the bond market.''

The yield on the 1 percent note due September 2013 fell 2 basis points to 0.88 percent as of 4:54 p.m. in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price rose 0.093 yen to 100.556 yen. The yield dropped 3 basis points, or 0.03 percentage point, this week.

Ten-year bond futures for December delivery advanced 0.15 to 138.37 at the afternoon close on the Tokyo Stock Exchange.

Japan's economy expanded 0.1 percent in the three months ended Sept. 30 from a year earlier, according to the median estimate of economists surveyed by Bloomberg News. Gross domestic product contracted 3 percent in the previous quarter.

Extra Funds

Bonds may extend gains as local money-market rates decline once the BOJ begins to pay banks interest for their reserves, said Tatsuo Ichikawa, a senior strategist at RBS Securities Japan Ltd. in Tokyo.

The BOJ said last month it will start paying 0.1 percent interest on the reserves, encouraging finance companies to lend excess cash to the central bank. The interest payments will also stop the overnight lending rate falling below 0.1 percent, allowing for the increased provisions of liquidity. The Federal Reserve adopted a similar measure on Oct. 6.

``Usually banks provide liquidity to each other, but as it's not working, the BOJ is stepping in,'' Ichikawa said. ``Now investors are providing liquidity to the BOJ and in turn, the BOJ is providing liquidity to investors. This may lead to a lower repo rate, which is positive for bonds.''

Japan's overnight call loan rate declined to 0.28 percent today, from 0.315 percent yesterday, according to broker Tokyo Tanshi Co.

Stock Gains

Ten-year bonds declined on speculation gains in stocks lured some investors to sell fixed-income assets.

The Nikkei 225 Stock Average advanced 2.7 percent, snapping three days of losses, after U.S. shares rallied the most in two weeks yesterday. The Standard & Poor's 500 Index surged 6.9 percent, led by energy and real-estate companies.

The yield on the benchmark 10-year note rose 1.5 basis points to 1.495 percent today.

Japan's bonds typically move in the opposite direction to stocks. Benchmark 10-year yields had a correlation of 0.7 with the Nikkei this month, according to data compiled by Bloomberg. A value of 1 would mean the two moved in lockstep.

Demand for longer-dated bonds also waned on concern the government will sell more debt to fund a stimulus plan to boost the nation's economic growth.

``Concern of additional issuance is strong'' and investors are in no rush to buy bonds, said Akihiko Inoue, an analyst in Tokyo at Mizuho Investors Securities Co., one of the 24 primary dealers required to bid at government debt sales.

Stimulus Package

Japanese lawmakers last month approved a 1.8 trillion yen ($18.5 billion) supplementary budget. Prime Minister Taro Aso Oct. 30 promised to pump an additional 5 trillion yen into the economy.

A ``couple of trillion yen'' of extra bond sales ``is fine, but a two-digit figure will have a negative impact on the Japanese market,'' said Yuuki Sakurai, general manager of financial and investment planning at Fukoku Mutual Life Insurance Co., which manages the equivalent of $54 billion in assets in Tokyo.

The Ministry of Finance will today hold a regular meeting with the 24 primary dealers to discuss its plans for next year's debt issuance.

Inflation-linked bonds worldwide are yielding more than conventional debt, signaling the global economy faces the risk of deflation.

The extra yield 10-year conventional Japanese bonds normally offer over similar-maturity inflation-linked debt, known as the breakeven rate, was at minus 160 basis points today, according to data compiled by Bloomberg.

The U.S. five-year breakeven rate was minus 48 basis points and the three-year U.K. breakeven spread was minus 33 basis points yesterday. A negative breakeven inflation rate reflects investor expectations for declining consumer prices over the life of the security.

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

Last Updated: November 14, 2008 02:58 EST