Japan's Notes Fall; Report Says BOJ May Raise Rates Next Month

May 9 (Bloomberg) -- Japan's government notes fell after a Nikkei Financial Daily opinion piece said the Bank of Japan may raise interest rates next month, earlier than economists expect.

Chances of an increase are rising after the central bank cut the money it makes available to lenders, according to the article on the commentary page. Nikkei Financial is published by Nihon Keizai, which also produces the world's largest-circulation daily business newspaper. Bank of Japan Governor Toshihiko Fukui said two days ago it ``will take a few weeks'' to drain excess money from the financial system, a precursor to raising borrowing costs.

``People are speculating the central bank will raise rates as early as June because the pace of reduction in the reserves is faster than expected,'' said Takashi Fujiwara, a trader in Tokyo at Resona Bank Ltd. ``The report is prompting some selling.''

The yield on the 1.4 percent note due in March 2011, one of the securities most sensitive to interest-rate changes, rose 3.5 basis points to 1.4 percent as of 5:15 p.m. in Tokyo at Japan Bond Trading Co. Yields earlier climbed to 1.415 percent, the highest since April 27. A basis point is 0.01 percentage point.

The central bank has cut the amount of money it makes available to lenders by almost half since on March 9 it started easing a five-year policy of pumping cash into the economy.

It held 17.3 trillion yen ($155 billion) in reserves yesterday, compared with 32.1 trillion yen, and has said it plans to reduce the funds to about 6 trillion yen over a few months. The balance may fall to about 10 trillion yen this month, according to Yuji Koyama, the reporter who wrote the column.

The Nikkei Financial in November 2004 caused the dollar to have its biggest drop in five weeks against the yen after the newspaper reported, without citing anyone, that the U.S. would tolerate weakness in its currency.

`Extreme View'

``It's sort of an extreme view that the BOJ will raise rates in June, but people are selling five-year and shorter debt to minimize risks just in case,'' said Tokyo-based Yoshimasa Kato, an investment manager at Shinkin Trust Bank Ltd., which holds the equivalent of $8.94 billion in assets.

Fukui made the comments in Basel, Switzerland.

Seven of the 16 economists surveyed by Bloomberg News last month said the central bank may raise rates as early as July, and six of them project the benchmark rate will be lifted to 1 percent or higher by the end of 2007.

Japan's central bank is also considering upgrading its view on the economy by using the word ``expansion'' for the first time in more than 14 years, Jiji Press reported, citing sources it didn't name. The report will be released next week.

Auction

Japan wants to keep bond yields down to limit costs to service the world's largest national debt, which the government estimates will take up a quarter of the budget this fiscal year. It had 749 trillion yen of marketable securities outstanding at the end of December.

Prime Minister Junichiro Koizumi forecasts it will spend 18.8 trillion yen to finance the deficit this year, the most since fiscal 2000. About 8.6 trillion yen of that amount is interest on outstanding debt, assuming 10-year bond yields average 2 percent, the government estimates.

Ten-year bonds advanced after an auction drew a higher lowest-accepted price than forecast.

The government's 1.9 trillion yen sale of the debt had the lowest accepted price of 100.25. The median estimate in a survey of 16 traders by Bloomberg News was for 100.24.

The sale drew bids worth 2.18 times the amount of debt sold, compared with 2.29 last month. The Ministry of Finance set a 2 percent coupon on the bonds, the highest since January 1999.

`Reasonable Demand'

Higher interest payouts may entice as life insurers that need to assure fixed returns to policy holders. Their investment will help the government to finance its public debt, the highest as a percentage of gross domestic product among the world's seven most industrialized nations.

``The auction drew reasonable demand given the level of pricing,'' said Tokyo-based Naomi Hasegawa, a senior fixed-income strategist at Mitsubishi UFJ Securities Co., the fifth-largest buyer at government debt auctions. ``Investors, like life insurers, may be interested in buying the high-coupon bonds should yields come closer to 2 percent.''

The yield on the 1.8 percent security due March 2016 fell 1 basis point to 1.96 percent. Benchmark 10-year yields rose to 2 percent on April 18, the highest since August 1999.

Money to Invest

Japan's life insurers will invest about 20 trillion yen in domestic government bonds should yields rise over 2 percent, Shinichi Yokoyama, chairman of the Life Insurance Association of Japan, said in April. Yokoyama is also president of Sumitomo Life Insurance Co., Japan's fourth-largest life insurer.

``With the high coupon on new debt and yields near 2 percent, investors may be keen on buying longer-maturity bonds,'' said Koji Mori, who oversees the equivalent of about $403 million in mutual funds at Daiwa SB Investments Ltd., an unit of Japan's second- largest brokerage. ``I see little chance for a rate hike in June. The Nikkei Financial report is just one opinion.''

Three-month euroyen futures indicate traders have started pricing in chances that the Bank of Japan may raise its target for overnight lending rates in June from near zero percent.

Contracts for June delivery yielded as much as 0.295 percent today, the highest since Nov. 10. Contracts for March 2007 suggested traders are betting the bank may raise rates to more than half a percentage point by March 31 next year.

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