Japan's foreign bond binge hits three-year high

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Weekly purchases of foreign bonds by Japanese investors surged to a three-year high last week, as low domestic rates encouraged local institutions to search for higher returns overseas.

Domestic investors, such as banks, pension funds and insurers, bought 1614.8 billion yen ($16.45 billion) in overseas debt during the week that ended August 10, following $690.3 billion in purchases a week earlier, according to weekly data from the Ministry of Finance. They have remained net buyers of foreign bonds for six consecutive weeks.

"This is really in line with what the BOJ wants: to encourage locals to move their funds abroad as it helps with the weakening of the yen," Nizam Idris, head of strategy, fixed income and currencies at Macquarie told CNBC.

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"With local rates likely to remain low, the increase in buying is likely to continue," he said.

Increased buying of overseas assets is seen as a key factor in driving further yen weakness. The currency has fallen 22.4 percent against the U.S. dollar since November 2012, when Prime Minister Shinzo Abe first started talking about the need for radical monetary and fiscal policies to revive the economy.

However, the trend of rapid depreciation has stalled in the recent weeks due in part on concerns that the government is not doing enough to tackle the long-term problems facing Japan's economy as well as weakness in the U.S. dollar.

The main destinations for Japanese liquidity include U.S. Treasurys, given to their low risk nature and liquidity of the market, Australia's AAA-rated government bonds as well as higher yielding peripheral European bonds, according to market watchers.

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The yield on 10-year Japanese government bond stands at 0.74 percent, compared with 2.7 percent in the U.S. and 3.9 percent in Australia.

Separately, data showed foreigners sold 148.6 billion yen worth of Japanese shares last week, the highest in five months and the third straight week of net selling, according to Reuters.

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Enthusiasm for Japanese equities has been waning in the recent weeks, with uncertainty over whether the government will push ahead with its planned consumption tax hike weighing on sentiment.

The Nikkei 225 has declined 4.9 percent over the past month. However, the index is still up 32.8 percent year-to-date.

—By CNBC's Ansuya Harjani; Follow her on Twitter @Ansuya_H