June 5 (Bloomberg) -- Japanese five-year notes rose on speculation a decline in the Nikkei 225 Stock Average boosted demand for the relative safety of government debt.

Yields approached a two-week low on concern credit-market losses may spread as U.S. and European financial firms release earnings. Moody's Investors Service said yesterday it may downgrade the world's biggest bond insurers and Lehman Brothers Holdings Inc. lowered its rating on the Japanese banking sector.

``While inflation is still the biggest focus of the market, some attention is paid to credit market concerns before earnings results of financial institutions, leading to debt buying,'' said Atsushi Ito, a strategist at Morgan Stanley Japan Securities Co. in Tokyo. ``Declines in stocks added support.''

The yield on the 1.3 percent note due March 2013 fell 2.5 basis points, or 0.025 percentage point, to 1.275 percent at 4:19 p.m. in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price rose 0.112 yen to 100.112 yen.

Ten-year yields declined 1 basis point to 1.73 percent. Yields may fall to as low as 1.65 percent by the end of this month, Morgan Stanley's Ito said.

Ten-year bond futures for June delivery gained 0.55 to 135.23 as of the afternoon close at the Tokyo Stock Exchange and the Nikkei 225 lost 0.7 percent.

The top ratings of MBIA Inc. and Ambac Financial Corp. were put under review and a downgrade is the ``most likely outcome,'' Moody's said yesterday, citing diminishing financial stability and the possibility of bigger insurance losses.

Japan's bonds often move in the opposite direction to stocks. Benchmark 10-year yields had a correlation of 0.61 with the Nikkei 225 so far this year, according to Bloomberg data. A value of 1 means the two moved in lockstep.

Focus on Inflation

Benchmark bonds have handed investors a return of about 1.7 percent in the past year, compared to a 10.2 percent return for holders of Treasuries, according to indexes compiled by Merrill Lynch & Co. The Nikkei has lost almost 20 percent in the period.

The gain in bonds was limited by speculation quickening inflation will erode the value of the fixed payments from debt.

``Accelerating inflation is the biggest theme in the debt market, which puts bonds under pressure to fall,'' said Takeo Okuhara, a senior economist and debt strategist in Tokyo at Daiwa Institute of Research Ltd., a unit of the nation's second- largest brokerage. ``Inflation expectations will grow further, dragging bond yields up, especially on the 10-year security.''

Crude oil futures reached a record $135.09 a barrel on May 22 and are up more than 27 percent year-to-date. Inflation in Japan slowed to 0.9 percent in April from 1.2 percent in March, which was the most since 1998, Japan's statistics office said May 30.

Debt Auction

The difference in yield between 10-year conventional securities and inflation-protected debt widened to the most since November this week, according to data compiled by Bloomberg. Inflation-linked bonds show that investors expect consumer prices to accelerate to an annualized 0.42 percentage point during the next 10 years, versus 0.43 point on June 3.

Japan's Ministry of Finance sold 500 billion yen ($4.7 billion) of 10-year inflation-protected debt today, drawing the highest bids since August. The sale attracted bids for 4.07 times the amount on offer, compared with a so-called bid-to- cover ratio of 2.9 in the previous sale on April 3. The average ratio last year was 3.9 times.

``The auction result was good,'' said Takashi Nishimura, an analyst at Mitsubishi UFJ Securities Co. based in Tokyo. ``Inflation is accelerating and that also led to optimism the liquidity of inflation-linked debt will improve.''

To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net; Yumi Teso in Singapore at yteso@bloomberg.net.

Last Updated: June 5, 2008 03:38 EDT