Japan 2-year bond yield slips ahead of auction as BOJ rate-hike bets build

Japan's two-year government bond yield edged lower on Wednesday, ahead of an auction of notes with the same maturity, as investors positioned for what is expected to be a lacklustre sale.

The 2-year JGB yield slipped 1.5 basis points to 1.945%. Earlier this week it had climbed to 1.975%, its highest level since March 1995.

The auction later in the day is expected to draw weak demand, with markets anticipating that the Bank of Japan will accelerate its rate-hike cycle and pricing in the possibility of another increase as early as October.

"There may be a demand for the bonds as the yield level is attractive, but it would be hard to buy the two-year bonds at the auction when the BOJ's rate hike as early as October is in sight," said Naoya Hasegawa, chief bond strategist at Okasan Securities.

Hasegawa added that a US Federal Reserve rate increase in October would pressure the yen, and that a consecutive rate hike by the BOJ can no longer be dismissed as an unrealistic scenario.

Swap rates imply a 36% chance of the BOJ raising rates to 1.5% in October, while traders have fully priced in such a move by December, according to money market broker Tokyo Tanshi.

Earlier this month, the BOJ raised its policy rate to a 31-year high of 1.25%.

The one-month interest rate swap rate starting in two years, which market players see as the end point of the policy rate, rose to a record 2.5% this week and was last at 2.46%.

The 10-year JGB yield edged up 1 basis point to 3.095%. Bonds with other maturities were yet to trade as of 0047 GMT.