LONDON: Government bond yields in Germany and France rose to seven-week highs on Wednesday, as a sell-off in Japanese government bonds rippled across major debt markets.
Japanese bond yields hit 1-1/2 year highs, reversing sharp falls the previous day, as investors tested the limits of the Bank of Japan's commitment to allow yields to move more flexibly.
Bank of Japan Governor Haruhiko Kuroda said on Tuesday the central bank would tolerate moves in the 10-year Japanese government bond (JGB) yield of about 20 basis points (bps) from its policy target of zero percent, wider than the range of 10 bps around the target allowed previously.
As traders put the BOJ's tolerance for higher yields to the test, the benchmark 10-year JGB yield rose to 0.12 percent in its biggest one-day rise in two years.
"JGBs have this new found freedom - so I expect them to act like a teenager with her/his first car...'test the limits'," Futures First Info Services interest rates strategist Rishi Mishra said.
In Europe, Germany's 10-year bond yield rose to a seven-week high at almost 0.48 percent and was last up 3 bps on the day.
French 10-year bond yields also hit seven-week highs, hitting 0.77 percent. Most other long-dated euro zone bond yields were up 1-4 bps on the day.
Massive monetary easing in Japan has helped push down borrowing costs in other parts of the world and encouraged Japanese investors to buy higher-yielding assets overseas.
Higher-rated bonds in the euro zone such as French and German debt have benefited from this Japanese buying but that also means they are at risk if rising JGB yields tempts Japanese investors back home. They owned more than 170 billion euros of French bonds at the end of 2017, Commerzbank estimates say.
"Since the BOJ was vague about what its flexibility means, the market wants to test the bank's pain threshold," Nordea chief analyst Jan von Gerich said.
"Is it 15 bps? Is it 20 bps? The higher it is, the more it will be taken as a sign that the BOJ is reluctant to intervene and if that is the case then maybe it is not keen to push ahead with easing and that has repercussions beyond Japanese borders."
Analysts said that while in the short-term there was some spillover from Japan's bond sell-off, a much bigger rise in JGB yields would be needed to have a significant impact on Europe.
Still, the rise in Japanese yields overshadowed fears of an escalation in US-China trade tensions in world markets that have tended to boost demand for safe-haven debt.
The US Federal Reserve meanwhile is expected to keep interest rates unchanged when it concludes its two-day policy meeting on Wednesday.
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