By Theresa Barraclough Dec. 2 (Bloomberg) -- Japanese government bond futures dropped after the Bank of Japan refrained from raising debt purchases at an emergency meeting yesterday. Benchmark securities had rallied after the central bank announced plans to meet, spurring speculation policy makers would increase monthly bond buying from 1.8 trillion yen ($20.8 billion). Yields on five-year notes climbed from near the lowest level since 2005 on concern the government will sell more debt to offset shrinking tax revenue. “The disappointment caused by the BOJ is weighing on the bond market,” said Kazuhiko Sano, chief strategist in Tokyo at Citigroup Global Markets Japan Inc. Ten-year bond futures for December delivery dropped 0.26 to 140.21 as of the afternoon close at the Tokyo Stock Exchange. The yield on the 0.7 percent note due September 2014 rose 1.5 basis points, or 0.015 percentage point, to 0.47 percent as of 3:01 p.m. in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price fell 0.073 yen to 101.076 yen. Ten-year yields traded at 1.24 percent today. It reached 1.19 percent yesterday, the lowest level since January. The policy board kept the key overnight lending rate at 0.1 percent, a level that BOJ Governor Masaaki Shirakawa said is already effectively zero. “If there is a shortage of liquidity we are prepared to provide more funds,” Shirakawa said after yesterday’s meeting. BOJ Policy The three-month interbank offered rate fixed in Tokyo, known as Tibor, fell below 0.5 percent for the first time since November 2006. Tibor declined two basis points, or 0.02 percentage point, to 0.494 percent in Tokyo, the biggest drop this year, according to the Japanese Bankers Association. Yesterday’s meeting came a month after the BOJ decided to phase out earlier lending measures and Prime Minister Yukio Hatoyama’s government warned about the danger of prolonged consumer-price declines. The government declared on Nov. 20 that Japan’s economy was in deflation. Consumer prices excluding fresh food slid 2.2 percent in October from a year earlier after dropping a near-record 2.3 percent in September. The central bank forecasts the declines will extend into fiscal 2011. Deflation blighted Japan during its so-called lost decade of stagnation after an asset bubble burst in the early 1990s. Deflation Looms The spread between rates on five-year notes and inflation- linked debt, which reflects the outlook among traders for consumer prices over the term of the securities, was negative 1.1 percentage point today, from minus 0.82 two weeks ago. Inflation-adjusted securities typically yield less than regular bonds because their principal payment increases at the same rate as inflation. Deflation, a general drop in prices, enhances the value of the fixed payments from bonds. Losses on medium-term securities were limited on speculation the central bank will eventually buy more debt, according to Credit Suisse Group AG. “The mid-term sectors should be well supported by hopes the BOJ will expand measures in the near future,” said Kenro Kawano, a debt strategist at Credit Suisse Group AG in Tokyo. Traders added to bets policy makers will reduce interest rates. Yields on euroyen contracts for December delivery fell to 0.435 percent today, from 0.505 percent at the end of last week at the Tokyo Financial Exchange. Bond futures may rise to the highest level in 21 months as trend indicators are showing buy signals for the contracts, said Katsutoshi Inadome, a strategist at Mitsubishi UFJ, a unit of Japan’s largest banking group. “I consider those momentum indicators secondary factors, so the mainstream trend remains bullish,” Tokyo-based Inadome said in an interview. Should the current contract close above 140 today, it will likely rise back toward 140.48, Inadome said. The level of “140 yen is an important psychological level.” To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net.

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