Japan's yield curve steepens as BOJ rate-hike bets fade on Middle East uncertainty

By Rocky Swift

TOKYO, April 16 (Reuters) - Japan's yield curve steepened on Thursday as expectations of an imminent interest rate hike by the central bank diminished, while concerns over the Middle East crisis weighed on the economic outlook.

The yield on the two-year Japanese government bond (JGB) , the one most sensitive to Bank of Japan's policy rates, decreased 0.5 basis point (bp) to 1.365%. The benchmark 10-year yield rose 1 bp to 2.415%. Yields move inversely to bond prices.

Investors are closely watching whether the BOJ will raise rates at its upcoming policy meeting, as the conflict involving Iran raises concerns of higher imported energy costs and a potential slowdown in economic growth.

The central bank can see through inflationary pressures as any second-round effects on broader prices will be limited, Rahul Anand, the International Monetary Fund's mission chief for Japan, told Reuters on Wednesday.

"Given recent trends, the retreat of expectations for an early rate hike is supportive for the medium-term bond market," Keisuke Tsuruta, a senior bond strategist at Mitsubishi UFJ Morgan Stanley Securities, wrote in a note.

"On the other hand, the long- and ultra-long-term bonds are unlikely to find support, given continued bets for gradual rate hikes and growing concerns about a 'behind-the-curve' scenario," he added.

The 20-year JGB yield climbed 3 bps to 3.270%, while the 30-year yield added 2.5 bps to 3.610%. The yield on the 40-year bond, Japan's longest tenor, rose 3 bps to 3.845%.

Japan's economy is particularly vulnerable to sharp rises in crude oil prices because of its heavy reliance on imported energy, and inflation erodes the real value of fixed bond payments.

"With decisions to release strategic oil reserves and provide gasoline subsidies in response to high oil prices, and amid concerns over increased defence spending, the risk of fiscal expansion remains a key focus," Barclays analysts wrote in a note. "The inflation risk premium suggests the possibility of yield curve steepening."