Aug. 24 (Bloomberg) -- Japan's five-year bonds had their biggest weekly decline in almost two months after the central bank signaled it still intends to raise borrowing costs.

Keeping interest rates too low could encourage risky investments and a misallocation of resources, Bank of Japan Governor Toshihiko Fukui said yesterday, after he and his policy colleagues voted 8-1 to keep the key overnight lending rate at 0.5 percent. Yields on five-year notes rose from 1.08 percent on Aug. 22, the lowest in almost a year.

``The BOJ won't change its plan to raise rates once every six months,'' said Nobuto Yamazaki, who helps oversee the equivalent of $6 billion in mutual funds at DLIBJ Asset Management Co. in Tokyo. ``The current level of the Japanese bond market is too high.''

The yield on the benchmark five-year note rose 7 basis points this week to close at 1.16 percent in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price of the 1.4 percent security due June 2012 fell 0.324 yen to 101.093 yen. A basis point is 0.01 percentage point.

Ten-year bond futures for September delivery gained 0.12 to 135.53 as of the afternoon close on the Tokyo Stock Exchange.

Central bank board member Atsushi Mizuno yesterday proposed a rate increase for the second straight meeting, dissenting with his other eight colleagues.

`Investors Aren't Confident'

Declines in bonds were tempered by concern losses related to U.S. subprime mortgages will slow global growth. The chief executive of Countrywide Financial Corp., the largest U.S. mortgage lender, yesterday said the nation's housing slump may lead to an economic contraction.

Countrywide Chief Executive Angelo Mozilo, speaking on CNBC television, said recent losses in credit markets were ``one of the greatest panics'' he's seen and the housing slump may lead to a recession. The company sold $2 billion of preferred stock to Bank of America Corp. this week to bolster its finances.

``The subprime-mortgage problem isn't over,'' said Shinji Hiramatsu, who helps manage the equivalent of $5.69 billion at Sompo Japan Asset Management Co. in Tokyo. ``Investors aren't confident enough to take risky assets yet.''

A U.S. government report today may show purchases of new U.S. homes fell in July for a third month to an annual rate of 820,000 units, according to the median forecast in a Bloomberg News survey. That would be the slowest pace since 2000.

Goldman Sachs Group Inc. yesterday changed its forecast for the dollar, saying it will fall to a record low against the euro within six months as housing weakness slows the U.S. economy. The Nikkei 225 Stock Average and the broader Topix index both fell 0.4 percent today.

Quicker Inflation

Bonds still declined on speculation yields need to be higher to attract investors given the nation's inflation rate may accelerate.

Japan's corporate service prices rose at the fastest pace in more than 15 years, adding pressure on businesses to retail prices. The company costs for services such as rent and transportation climbed 1.6 percent in July from a year earlier after gaining 1.5 percent in June, the Bank of Japan said today in Tokyo.

``For long-term investors, current levels of yields are too low,'' said Susumu Kato, chief economist at Calyon Securities in Tokyo. A rate increase by the European Central Bank and a failure to reduce borrowing costs by the Fed may push up bond prices and cause a ``spike'' in yields, he said.

There is still more than a 90 percent chance the Bank of Japan will increase rates this year, although policy makers are likely to wait until the U.S. subprime crisis eases, DLIBJ Asset Management's Yamazaki said.

To contact the reporters on this story: Oliver Biggadike in Tokyo at obiggadike@bloomberg.net; Masaki Kondo in Tokyo at mkondo3@bloomberg.net.

Last Updated: August 24, 2007 07:58 EDT