Japanese annual inflation hit a decade-high of 1.2 percent in March, helping trigger one of the biggest ever sell-offs in yen bonds as investors realised Japan has no immunity from price pressures facing the rest of the world, and that could eventually lead to a rate hike despite a weak economy, Reuters reported. Trading in bond futures on the Tokyo Stock Exchange was halted for a time to allow the market to settle, the first test of a circuit breaker mechanism introduced to the market this year. Like other central banks, the Bank of Japan faces rising fuel, raw materials and food prices as it ponders what to do with rates, already at a very low 0.5 percent in Japan. But because the increases in consumer prices in major economies are largely due to climbing costs, rather than strengthening demand, investors have until recently been eyeing more rate cuts, rather than hikes. Japan's core inflation rate of 1.2 percent, issued on Friday, was just as economists had forecast but it reinforced the pressure on the BOJ to keep inflation under control, and shifted investors' focus towards an eventual rate hike. "It is hard to think that the Bank of Japan's stance on monetary policy will change just because of a rise in cost-push inflation," said Mamoru Yamazaki, chief economist at RBS Securities. "But it may stir talk among market players that it may become more difficult for the BOJ to lower interest rates." The yield on two-year Japanese government bonds the most sensitive to interest rate expectations, jumped to a six-month peak, with investors affected as much by rate expectations in the United States and other major economies as the outlook for Japan. "The market is now moving on the view that the worst is behind us in the subprime-related woes, which is spurring a sharp reversal in positions that had bet on a bearish outlook on the economy and financial markets," said Yasuhiro Onakado, chief economist at Daiwa SB Investments, but he warned the market might go too far. "As the markets settle from the sharp unwinding of positions tilted excessively towards such a bearish view, players will come to realise that time is needed to resolve the credit market problems and see the U.S. economy recover and see bonds as being oversold." Swap contracts on the overnight call rate, the BOJ's key policy target, suggested a 25 percent chance of a BOJ rate hike by the end of the year.
