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Finance

Slow inflation, negative yields distort JGB market

TOKYO -- Persistently low inflation and plunging interest rates have led to some peculiarities in Japanese government bond offerings, including a turn away from inflation-indexed notes and a surge of demand for straight bonds.

     The Finance Ministry proposed at a meeting with brokerages Wednesday to scale back its April float of inflation-indexed bonds to 400 billion yen ($3.54 billion) from the originally planned 500 billion yen. The attendees generally agreed. The ministry will make a similar proposal to investors Thursday and set the size of the float next week. This would be the first cut to an offering of inflation-linked bonds since Japan resumed issuing them in fiscal 2013.

     Demand for inflation-indexed bonds is stronger when inflation expectations are high. Expectations have been lower lately, due partly to the impact of oil prices. The expected inflation rate, an indicator used in investment decisions, has slid from more than 1% in 2014 to around 0.3% now, according to the Finance Ministry.

     Market demand has fallen off sharply as a result, with far fewer investors participating in auctions for inflation-linked bonds. The Finance Ministry plans to adjust the supply-demand balance by both issuing less debt and setting up a system for the government to buy inflation-linked bonds held by investors.

     The fiscal 2016 plans put together late last year by the ministry call for floating 500 billion yen in inflation-indexed bonds each quarter, for a total of 2 trillion yen. Market players contend that adjusting this three months later -- just before the start of the new fiscal year in April -- will help normalize the market.

     Straight JGBs have also been affected. Strong demand for notes carrying maturities of 10 years or less has brought yields into negative territory. This generates a profit for the government, which had taken in at least 55 billion yen from investors through mid-March.

     The Bank of Japan has purchased nearly all outstanding straight JGBs as part of its massive monetary easing program. Even investors who bid for bonds issued under negative interest rates turn a profit by reselling them to the central bank. This has created a different environment than that for inflation-indexed bonds, for which the BOJ has bought only about a tenth of what has been issued -- not enough to make a dent in supply.

     The government has estimated long-term interest rates for fiscal 2016 at 1.6%. It would save more than 1 trillion yen in debt-servicing costs if rates remain around zero, stemming fiscal deterioration in the short term. But low borrowing costs could bring calls for more spending, leading to lax fiscal discipline in the long run.

(Nikkei)

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