Japan’s 10-year bonds completed a two-week advance on concerns lingering deflation and a strong yen will encourage the central bank to continue liquidity operations, boosting demand for fixed-income securities. Ten-year yields dropped to a seven-year low as the yen stayed near a seven-month high versus the dollar and economists said a report next week will show consumer prices fell for a 16th month. Japan’s government bonds returned 0.2 percent so far this month, adding to a gain of 2.2 percent between January and June, the best first half since 2001, according to an index compiled by Bank of America Corp’s Merrill Lynch & Co. unit. “There is no clear sign that Japan will come out of deflation, while a strong yen adds to such pressure,” said Takeshi Minami, chief economist in Tokyo at Norinchukin Research Institute Ltd. “The Bank of Japan is nowhere near the exit from monetary easing, allowing bond yields to stay low.” The yield of the benchmark 10-year bond fell two basis points this week to 1.065 percent in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price of the 1.1 percent bond due in June 2020 rose 0.179 to 100.313 yen. Yields reached 1.045 percent on July 22, the lowest since August 2003. A basis point is 0.01 percentage point. Ten-year bond futures for September delivery gained 0.03 this week to 141.69 yen at the Tokyo Stock Exchange after touching 142.08 on July 22, the most since August 2003. CPI, Yen Consumer prices excluding fresh food slid 1.1 percent in June from a year ago after dropping 1.2 percent in the previous month, according to a Bloomberg survey ahead of the July 30 data. The yen touched a seven-month high of 86.27 reached on July 16. The country’s large manufacturers expect the yen to average 90.16 per dollar in the six months to March 2011, according to the Bank of Japan’s quarterly Tankan survey released on July 1. “Japan is close to foreign-exchange intervention, with the pain threshold probably between 80 to 85 per dollar,” wrote Richard Jerram, Asian economics head at Macquarie Securities Ltd. in Tokyo. “We would expect the Bank of Japan to accommodate any intervention with a parallel expansion of its balance sheet, but it is far from clear that even this would be effective.” Vice Finance Minister Motoshisa Ikeda told reporters in Tokyo on July 22 that the government wants to “avoid excessive gains in the yen.” The day before, Trade Minister Masayuki Naoshima said the currency’s gains pose a risk to growth. Yield Gap Bonds also gained on speculation the U.S. economic recovery will slow as stimulus measures expire. The Conference Board’s confidence index fell to 51.8 this month from 52.9 in June, according to a survey before the July 27 data. The Institute for Supply Management-Chicago Inc.’s business barometer slid to 56.0 in July from 59.1 the previous month, a separate survey showed before the July 30 report. “Shrinking yield gaps between Japan and the U.S. stemming from concerns about the U.S. economy leave the risk of a strong yen, which will add to the deflationary pressure in Japan,” said Junko Nishioka, chief economist at RBS Securities Japan Ltd. in Tokyo. “The BOJ may need to take more action if the yen appreciates to beyond 85 per dollar, thereby giving impetus for yields to stay low.” The premium on U.S. two-year swap rates over same-maturity instruments in Japan dropped to as little as 34 basis points this week, the narrowest since 1993. Bonds fell yesterday, ending a two-day advance, as signs of a sustainable recovery in the world’s second-largest economy and gains in Asian stocks cut demand for the safety of debt. No Collapse “The economy is not going to collapse, contrary to extreme concerns that had engulfed the market recently,” said Hirokata Kusaba, a senior economist in Tokyo at Mizuho Research Institute Ltd., a unit of Japan’s second-largest banking group. “Bond yields, which have fallen to current levels on such concerns, are not sustainable.” Japan’s exports rose for a seventh month, gaining 23.5 percent in June from a year earlier, according to a Bloomberg News survey of economists ahead of the data on July 26. Factory output increased for a fourth month, climbing 0.2 percent in June from May, a separate survey showed before the July 30 data. The Nikkei 225 Stock Average gained 2.3 percent yesterday and the MSCI Asia Pacific Index of shares added 1.6 percent.

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