Nov. 4 (Bloomberg) -- Japanese bonds fell after Finance Minister Hirohisa Fujii said the government will likely use debt sales to meet a tax revenue shortfall, raising concern increased supply will overwhelm demand.

Brokerages also sold futures contracts as a hedge before bidding at a Ministry of Finance auction of 2.1 trillion yen ($23.3 billion) in 10-year securities tomorrow. The ministry said last week it will increase annual sales of government bonds in the fiscal year ending in March 2010 by 2.1 trillion yen to a record 132.3 trillion yen. The estimate did not factor in a shortfall in tax revenue.

“Supply concerns are now perceived by investors as a negative lead for bonds,” said Shinji Nomura, chief bond strategist at Nikko Cordial Securities Inc. in Tokyo. “Investor activity will dwindle ahead of tomorrow’s auction.”

Ten-year bond futures for December delivery fell 0.31 to 137.96 yen at the afternoon close of the Tokyo Stock Exchange. Japan’s financial markets were closed yesterday for a holiday.

The yield on five-year notes rose 2.5 basis points to 0.670 percent as of 4:20 p.m. in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker.

Yields on 10-year debt increased two basis points to 1.395 percent and rates on 20-year debt also added two basis points to 2.115 percent. A basis point is 0.01 percentage point.

‘Body Blow’

“Given falling tax revenue, additional sales of new financing bonds may come in at 10 trillion yen or more,” said Hirokata Kusaba, senior economist in Tokyo at Mizuho Research Institute Ltd., a unit of Japan’s second-largest banking group. “Concerns over debt supply are gradually affecting the debt market like a body blow.”

The prior sale of 10-year debt on Oct. 6 attracted bids worth 3.5 times the amount on offer, the highest ratio since May 2007. The ratio was 2.88 times at the September offering.

Primary dealers, which are required to bid at government auctions, tend to reduce debt holdings and sell futures in case they fail to pass on the new securities before prices decline.

Yields on most bonds climbed before a report this week that economists said will show Japan’s broadest indicator of economic health rose for a sixth month in September. Japan’s coincident index, a composite of 11 indicators including factory production and retail sales, climbed to 92.5 in September from 91.2 in the previous month, according to a Bloomberg News survey of economists before the data on Nov. 6.

More Balanced

“As the economic recovery continues, riskier assets such as stocks will continue to outperform debt, pushing up yields,” said Makoto Yamashita, chief Japan interest-rate strategist at Deutsche Securities Inc. in Tokyo.

Bank of Japan Governor Masaaki Shirakawa said today upside and downside risks for the economy are becoming more balanced. He was speaking at an economic forum hosted by Kyodo News Service in Tokyo.

The Bank of Japan last week said it will stop buying corporate debt and commercial paper at the end of this year.

Globally, central banks are phasing out measures taken at the height of the financial crisis. Axel Weber, head of Germany’s Bundesbank, signaled last week the European Central Bank may pull back its handouts of emergency liquidity next year while Australia and Norway have raised interest rates.

To contact the reporter on this story: Yasuhiko Seki in Tokyo at Yseki5@bloomberg.net

Last Updated: November 4, 2009 02:41 EST