Sept. 12 (Bloomberg) -- Japan's government bonds had the biggest decline in three weeks as stocks rallied after an election victory for Prime Minister Junichiro Koizumi fueled optimism he will carry out policies to spur economic growth.

``Koizumi's overwhelming victory was a surprise,'' said Masahiro Kami, who helps oversee the equivalent of $5.95 billion in Tokyo at Daiwa SB Investments Ltd., a subsidiary of Japan's No. 2 brokerage. ``Further gains in stocks will fuel optimism about the economy, pushing up bond yields.''

Benchmark 10-year bond yields rose to the highest this month on signs the world's second-largest economy is recovering from last year's recession. Japan's government tripled its second-quarter growth figure to 3.3 percent and the Nikkei 225 Stock Average gained to its highest close in more than four years.

The yield on the 1.4 percent bond due in September 2015 rose 2.5 basis points, the most for a benchmark bond since Aug. 22, to 1.365 percent as of 3:03 p.m. in Tokyo at Japan Bond Trading Co. The yield was the highest since Aug. 30. A basis point is 0.01 percentage point.

The bond's price fell 222 yen per 100,000 yen face amount to 100.307. Ten-year yields may rise to about 1.4 percent in the coming days, Kami said. Ten-year bond futures for December delivery dropped 0.28 to 139.22 as of the 3 p.m. close at the Tokyo Stock Exchange.

Koizumi's ruling Liberal Democratic Party and its coalition partner New Komeito yesterday won a majority 327 seats in the lower house. The LDP alone has 296 seats, the first time it captured a single-party majority in the lower house in 15 years.

Selling Japan Post

The prime minister called the elections on Aug. 8 after lawmakers rejected his plan to sell Japan Post, the world's biggest financial institution with 388 trillion yen ($3.55 trillion) in assets, and made the vote a referendum on his policies. The Nikkei has gained 9.5 percent since then.

Koizumi has ``had a phenomenal success. It's a big confirmation of his mandate,'' said Rob da Silva, who helps manage the equivalent of about $776 million of bonds as head of fixed income in Asia Pacific in Sydney at Principal Global Investors. ``Bonds could well trade a little lower in price. We're happy to keep our short position.''

A short position means investors borrow and sell an asset in anticipation of buying it back at a cheaper price.

Da Silva is keeping the duration of the Japanese bonds in his holdings below that of his benchmark, the Lehman Asian Aggregate Index. Duration is a measure of sensitivity to changes in yields.

Eroding Demand

Japan's GDP growth compared with a previous estimate of 1.1 percent, and the 1.5 percent median forecast of 18 economists surveyed by Bloomberg News.

When Koizumi became prime minister four years ago, the economy was in its third recession since the so-called asset price bubble burst in 1991.

Signs of an economic expansion may sap demand at the government's 2 trillion yen sale of five-year notes tomorrow.

The economic recovery is ``well-balanced'' and core consumer prices will likely stop falling or start to rise at the end of this year, Bank of Japan Governor Toshihiko Fukui said on Sept. 8.

``There's concern about demand for new five-year notes as signs of economic recovery raised speculation an end of easy monetary policy will come sooner than later next year,'' said Naomi Hasegawa, a senior fixed-income strategist at Mitsubishi Securities Co. in Tokyo, the fourth largest buyer at government debt auctions. ``Japan avoided political chaos with Koizumi's strong victory, which provides a fair wind to stocks and a recovery scenario.''

Ten-year yields may rise to 1.4 percent this week, she said.

1.4 Percent

The central bank in March 2001 pushed overnight loan rates between banks to near zero by raising its target for reserves available to lenders. The central bank has said it won't increase rates until consumer prices rise and show no sign of falling.

Declines in bonds were limited by speculation oil prices near a record high will slow consumer spending and growth in the U.S., Japan's biggest export market.

``The risk of economic slowdown will increase towards the end of the fiscal year and the impact of the high crude oil prices remains as a concern,'' said Eiji Dohke, chief strategist at UBS Securities Japan Ltd. in Tokyo, one of the 28 primary dealers that are required to bid at auctions. ``My basic stance on recommendation for bonds is a buy.''

Ten-year yields may fall as low as 1 percent by the end of March, Dohke said.

Crude oil futures for October delivery on Aug. 30 rose to a record $70.85 a barrel as Hurricane Katrina struck energy hubs along the Gulf Coast in the U.S. Exports make up a 10th of Japan's economy, with about a fifth of those going to the U.S.

Bonds still dropped as stocks gained, luring investors away from debt's fixed payments.

The Nikkei 225 rose 1.6 percent to 12,896.43, its highest close since June 2001.

To contact the reporter on this story: Keiko Ujikane in Tokyo at kujikane@bloomberg.net.

Last Updated: September 12, 2005 02:13 EDT