Aug. 18 (Bloomberg) -- Japanese five-year notes advanced, sending yields down to the lowest level in more than five weeks, after a sale of 2.3 trillion yen ($24.3 billion) in the securities drew the highest demand in more than a year.

Five-year notes gained for a fifth day, the longest winning stretch since June, on speculation domestic banks are using deposits to purchase bonds as lending demand slows. Primary dealers submitted bids worth 3.5 times the amount on offer, compared with a so-called bid-to-cover ratio of 3.3 times at the July auction. The ratio was the highest since July last year.

“The auction was very good,” said Takashi Nishimura, a Tokyo-based analyst at Mitsubishi UFJ Securities Co., a unit of Japan’s largest bank by assets. “Deposits are increasing and lending is declining, so banks have a lot of cash and they have to put it somewhere. That somewhere is bonds.”

Five-year yields fell one basis point, or 0.01 percentage point, to 0.66 percent as of 4:25 p.m. in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price gained 0.047 yen to 100.187 yen. The yield earlier touched 0.655 percent, the lowest level since July 10.

Ten-year yields were unchanged at 1.34 percent, after touching 1.335 percent, the lowest since July 21. Bond futures for September delivery added 0.16 to 138.75 as of the afternoon close at the Tokyo Stock Exchange.

The lowest price at the sale of the 0.7 percent five-year notes was 0.01 yen below the average, compared with a spread of 0.02 at the previous sale. The so-called tail is the difference between the lowest and the average price. The shorter the tail, the more bids are clustered around the average price.

Bank Demand

Outstanding loans have fallen for four straight months, the longest decline since 2004, according to the Bank of Japan.

Banks in the nation such as Mitsubishi UFJ Financial Group Inc. and Mizuho Financial Group Inc., the two largest by assets, owned a record 111.9 trillion yen of the securities at the end of May, the most since central bank figures started in 1993.

Demand for bonds was limited as a chart that traders use to monitor prices changes signaled that 10-year bonds had gained too quickly. The 10-day relative strength index on 10-year yields was 32 yesterday, near the 30 level, which suggests that the securities are overbought and poised to decline. Ten-year notes advanced this month, with yields sliding 7.5 basis points.

“Given that 10-year yields are approaching 1.3 percent, buyers may start to withdraw,” said Kazuhiko Sano, chief strategist at Nikko Citigroup Ltd. in Tokyo.

Ten-year yields are likely to increase to 1.42 percent by the end of the year, according to a Bloomberg News survey of economists and analysts. The estimate puts a heavier weighting on more recent forecasts.

Looming Election

Bonds have handed investors a loss of 0.2 percent so far this year. Demand for the securities weakened as Prime Minister Taro Aso struggled to steer the economy toward a recovery as his ruling Liberal Democratic Party trailed the opposition Democratic Party of Japan in polls ahead of an Aug. 30 election.

“The biggest risk factor for the bond market is uncertainty over how the DPJ will manage fiscal policy,” said Hirokata Kusaba, senior economist in Tokyo at Mizuho Research Institute Ltd., a unit of Japan’s second-largest banking group. “If the DPJ tries to implement its policy commitments without showing any future plan to fix the swelling debt problem, investors may need to ask a higher premium to hold government bonds.”

Month-End Buyers

Longer-term securities may advance amid speculation money mangers will buy debt to match a month-end change in the benchmark index they use to gauge performance, according to UBS Securities Japan Ltd., one of the 23 primary dealers required to bid at government debt sales.

“I recommend buying bonds,” said Eiji Dohke, chief strategist in Tokyo at UBS Securities Japan Ltd. “The duration extension into next month will be longer than usual.”

Nomura Securities Co. increased the average duration of its Bond Performance Index by 0.05 year to 6.34 years this month, according to the company’s Web site. The duration extension for next month will be posted on the company’s Web site next week.

Money managers such as Japan’s Government Pension Investment Fund, which runs the world’s largest pool of retirement wealth, use Nomura’s index to help decide their holdings. Duration is a gauge of how much a change in yield affects a bond’s price.

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

Last Updated: August 18, 2009 03:31 EDT