Japanese government bond futures rose to a three-week high on Monday after the Bank of Japan's June tankan survey generally matched forecasts, reinforcing market views that a rate hike could come as early as August.
The as-expected tankan results came after Friday's soft reading on Tokyo consumer prices helped beef up expectations the BOJ would stick to a gradual pace of lifting interest rates and dispelled talk of a rate hike this month.
The BOJ will hold a policy meeting next week.
The headline figures are as expected, but there are a few worrying points, such as current as well as future weakness in smaller firms, and a drop in the sentiment index for the raw materials sector, said Mari Iwashita, a fixed-income strategist at Daiwa Securities SMBC.
The quarterly tankan survey also showed companies were still refraining from raising prices despite rising costs, while a flat business outlook for big companies suggested their activities are on a plateau now, Iwashita said.
The survey does not, however, affect the general scenario of the economy or expectations for a Bank of Japan rate hike, she said.
Most investors expect the BOJ to raise rates in August to 0.75 percent from the current 0.50 percent. Swap contracts on the overnight call rate showed a 73 percent chance of a rate rise in August, down from 77 percent on Friday.
September futures ended the morning session up 0.08 point at 132.09, easing from day's high of 132.23, their highest level since early June.
The benchmark 10-year yield eased 1 basis point to 1.860 percent while the yield on five-year notes inched down 0.5 basis point to 1.465 percent.
Lead March euroyen futures were down 0.005 at 98.865.
Traders said a rise in U.S. Treasuries on Friday also helped improve sentiment in the JGB market.
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Stability in the Treasury market and JGBs, after a sharp sell-off in early June, may encourage buying by investors looking to park their money and help consolidate a market floor, said a senior trader at a big Japanese bank.
But expectations for an August rate hike were likely to put a cap on gains, the trader said.
Nobody expects a July rate hike, but because the main scenario remains an August rate increase, the market can't continue to buy bonds and push yields steadily lower, he said.
It makes it easier for investors to buy at current levels which have factored in an August rate hike. But their buying will be cautious.
The market could extend gains later in the session in technically driven buying ahead of the Ministry of Finance's offer of 1.9 trillion yen ($15.43 billion) of 10-year JGBs on Tuesday.
Traders have said there is some demand in the market for a reopening of the previous 1.8 percent issue.
Traders expect few surprises from speeches by BOJ board members.
BOJ Deputy Governor Toshiro Muto will speak at a Tokyo seminar on Tuesday, while board member Kiyohiko Nishimura will give a speech at a seminar in Washington on Monday.