Japanese bond yields surge on inflation concerns and BOJ signals

(Updates yields, adds analyst comment and background on BOJ output gap data)

By Satoshi Sugiyama

TOKYO, March 27 (Reuters) - Japanese government bond yields rose on Friday, with five-year yields hitting a record high, as the Middle East conflict and recent central bank signals heightened inflation concerns and led investors to reprice the path of rate hikes.

The five-year yield rose 6 basis points (bps) to 1.800%, while the benchmark 10-year JGB yield climbed 8 basis points to 2.350%, a two-month high. Yields move inversely to bond prices.

Japan remains highly exposed to spikes in crude oil prices due to its heavy reliance on imported energy. Higher oil costs tend to feed into domestic inflation, eroding the real value of fixed-income securities and adding pressure on the central bank to tighten monetary policy.

The Bank of Japan's revised output gap data released on Thursday showed demand exceeded supply capacity for a 15th straight quarter, overturning its previous estimate that had indicated excess supply for about five and a half years. The outcome pointed to a greater likelihood of rising prices.

On top of the war in the Middle East, such BOJ data suggested inflationary pressures in Japan may be more persistent, prompting investors to be more cautious on bonds, said Ryutaro Kimura, senior fixed-income strategist at AXA Investment Managers.

"Up until (Thursday), rates were rising more in the swap market, driven by foreign investors who saw Japan as underpricing BOJ hikes relative to Europe and the U.S., and possibly underestimating the impact of the Middle East situation," he said.

"But today, with the move more evident in the cash bond market, domestic investors also seem to be revising their view towards the idea that the BOJ may have to raise rates faster and to a higher level than previously expected."

The two-year yield, the one most sensitive to BOJ policy rates, increased 4.5 bps to 1.38%, the highest since May 1995.

The 20-year JGB yield climbed 6 bps to 3.180%. The 30-year yield added 4.5 bps to 3.565%. The 40-year JGB, Japan's longest tenor, was yet to be traded, as of 0453 GMT. (Reporting by Satoshi Sugiyama; Editing by Sumana Nandy and Subhranshu Sahu)