By Takaya Yamaguchi and Hideyuki Sano
TOKYO (Reuters) - Struggling to stem a rout in government bond prices, the Bank of Japan said on Wednesday it will pump a massive amount of cash into the Tokyo money market.
The offer to inject 2.8 trillion yen in market operations on Friday is more than three times the size usually offered in a single day.
The announcement briefly reversed a spike in bond yields that began last Friday, but rates ended higher for a fourth session as JGB investors are starting to rethink whether Japan will forever be mired in deflation and as the central bank continues its attempts to manage a flood of liquidity it unleashed on the markets last month.
Prime Minister Shinzo Abe's radical reflationary policies have sent Tokyo shares surging to 5-1/2-year highs and the yen to 4-1/2-year lows against the dollar, but bond prices had moved much less until last week.
Now Japanese banks - which had heavily bought JGBs for years as the sluggish economy meant a dearth of borrowers to lend to - are dumping bonds in the wake of "Abenomics" and the BOJ's easing, which aims to end 15 years of deflation with modest price rises.
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On Wednesday Abe urged the BOJ to bring order to the highly volatile JGB market as concerns grow that yield rises could get out of control, eventually complicating the government's ability to service its enormous debt burden.
The BOJ's historic easing includes gobbling up JGBs equal to 70 percent of bond issuance for two years to help spur consumer inflation of 2 percent.
"It is certain the BOJ's massive JGB buying under its 'qualitative and quantitative easing' could have major effects on the bond market," Abe said, answering questions in parliament. "I expect that the BOJ will respond appropriately."
The central bank's offer of a massive injection of funds on Friday was "a response to sharp rises in longer-term interest rates," said an official with the BOJ's Financial Markets Department.
The benchmark 10-year Japanese government bond yield, after spiking to 0.920 percent in early trade, its highest level in over a year, reversed course on the BOJ announcement to fall back below Tuesday's close. But a lack of follow-through buying saw the rate head higher again to stand at 0.865 percent in late trade, up one basis point for the day.
The 10-year yield has surged 28 basis points since the rout began on Friday, the biggest four-day spike since August 2003, according to Datastream figures.
The BOJ will offer 800 billion yen in one-month funds and 2 trillion yen in one-year funds on Friday. It usually offers just 800 billion yen in one-month funds for such operations.
The announcement was similar to, but less dramatic than, a huge funding operation the BOJ conducted during market turbulence shortly after it unveiled its massive monetary easing plans on April 4. For that month the central bank injected 7.2 trillion in one-year funds, a rare maturity for the BOJ.
A spur for the JGB sell-off was the yen's most recent sharp drop, with the dollar finally cracking above the psychologically key 100-yen line. This has driven some bond investors, long sceptical about the BOJ's ability to end deflation, out of JGBs.
BOJ Governor Haruhiko Kuroda said on Wednesday that the weaker yen can contribute to ending deflation by boosting import prices but that the central bank is aiming at "balanced" inflation that also reflects rising inflation expectations as well as economic demand catching up with over-supply in the economy.
Kuroda was speaking in parliament, where he was not asked about the JGB market.
Bond market players expect more bumps ahead.
"There's the underlying fact that the BOJ's massive bond buying is drying up market liquidity and making the market volatile," said Naomi Muguruma, senior strategist at Mitsubishi UFJ Morgan Stanley Securities.
But the bond sell-off could subside possibly after a five-year debt auction on Thursday, some market players said.
"I think we'll see selling climax in a couple of days. The target is 1 percent in the 10-year yield and 0.5 percent in the five-year yield," said Takeo Okuhara, fund manager at Daiwa SB Investments. (Additional reporting by Leika Kihara, Tetsushi Kajimoto and Stanley White; Writing by William Mallard; Editing by Kim Coghill)