JGB yields fall to 5-month lows as BOJ underpins prices
* 10-yr, 20-yr yields drop to their lowest levels since May
* Without BOJ, 10-yr yield would be 120 bps higher-strategist
* BOJ expected to maintain policy at this week's meeting
TOKYO, Oct 2 (Reuters) - Japanese government bond yields fell to nearly five-month lows on Wednesday, a day after the government announced a historic tax hike and stimulus package, underscoring that bond investors expect the Bank of Japan to keep the pressure on yields.
Prime Minister Shinzo Abe said on Tuesday that Japan will increase its national sales tax to 8 percent in April from 5 percent, and also unveiled a 5 trillion yen ($51 billion) stimulus package to cushion the economic impact.
The BOJ pledged in April to inject some $70 billion a month into the economy to meet a target of 2 percent inflation in two years. Some economists have said they expect the BOJ to deliver more easing measures as early as next spring, to keep the nascent recovery on track.
Even after Tuesday's announcement of the massive stimulus package, the yield on the benchmark 10-year JGB fell 1 basis point to 0.645 percent on Wednesday, its lowest since May 10.
"You would never get these yield levels from a fundamental perspective," said Shogo Fujita, chief Japan bond strategist at Bank of America Merrill Lynch in Tokyo.
"We finally got the consumption tax hike, but we still have fiscal issues. Fundamentals are still pointing to higher yields in Japan, and the only thing keeping yields at these levels is the central bank," he said.
On Wednesday, as part of its normal bond-buying operations, the BOJ offered to purchase some 300 billion yen of JGBs maturing in one to three years, 350 billion yen of JGBs maturing in three to five years, and 400 billion yen of JGBs maturing in five to 10 years.
"All things being equal, if you take out the BOJ from the equation, yields should be at least 120 basis points higher on the 10-year, according to our rates model," Fujita said.
The BOJ's nine-member policy board will hold a regular meeting on Thursday and Friday, at which it is widely expected to stand pat. Governor Haruhiko Kuroda is likely to welcome the sales tax hike, which he had publicly supported as a first step in tackling Japan's huge public debt.
Ten-year JGB futures ended morning trade up 0.09 point at 144.32, with foundering stocks also supporting bond market sentiment.
The Nikkei stock average slipped 0.7 percent, as the previous session's stimulus announcement offered little impetus for fresh buying. The dollar slipped about 0.1 percent to 97.89 yen, moving back toward a one-month low of 97.48 yen hit on Monday.
The superlong JGB sector also gained, with the 20-year yield losing 1.5 basis points to 1.530 percent after earlier touching 1.515 percent, its lowest since May 9.
"In September, the monthly duration extension put additional flattening pressure on the JGB yield curve. However, the current superlong JGB yield levels are not high enough for end-investors to purchase, such as life insurers," said Naomi Muguruma, senior market economist at Mitsubishi UFJ Morgan Stanley Securities.
Funds typically buy super-long JGBs toward the end of months to lengthen the average duration of their portfolios.
In the last trading days of September, JGBs also gained as they tracked U.S. Treasuries on safe-haven appeal amid concern about the economic fallout of a U.S. government shutdown.
U.S. President Barack Obama and congressional Republicans remained at a standoff on Tuesday that forced the first government shutdown in 17 years and furloughed hundreds of thousands of federal employees.
"The current JGB curve flattening will probably be unwound in the future, but first we need to know when the U.S. government shutdown problem will be cleared, to unwind the flattening trade," Muguruma said.