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Kokusai Asset Management Co., which runs the world’s second-largest bond fund, said Japanese government bond yields may drop to a record, even as larger fund supervisor Pacific Investment Management Co. expressed concern about the nation’s rising debt levels.

Yields on 10-year JGBs may slide below 1 percent toward a record low reached in 2003 if concern about an economic slowdown increases, said Akio Kato, team leader for Japanese debt at Kokusai.

Bonds may gain as the Democratic Party of Japan and its ruling bloc, which lost their Upper House majority in Sunday’s election, reaches out to smaller parties by demanding the Bank of Japan do more to keep borrowing costs low, he said.

Pimco is limiting JGB investments on concern about the sustainability of demand for the world’s biggest public debt.

“When policymakers face gridlock, they tend to turn to the BOJ,” said Kato at Kokusai, which runs the $39 billion Global Sovereign Open fund, Asia’s biggest. “They are wondering how to spur and maintain growth when the global economy is losing momentum. They will ask the BOJ to do more.”

Ten-year yields are poised to drop below 1 percent by the end of September, he said.

Pimco said the government bonds face declines in the longer term. The public pension fund sold more government securities than it bought in the 12 months that ended March 31, the first net sales in nine years, underscoring concern that the aging population will make domestic investors less able to finance government borrowings.

“Once Japan is dependent upon non-Japanese investors to support the JGB market, we do foresee some problems,” David Fisher, head of global product management for Pimco, said Tuesday in Tokyo. “This is one of the main reasons why in the global bond portfolio we have very, very limited exposure to JGBs despite the fact that yields are not so terribly unattractive on a hedged basis.”

The benchmark 10-year bond yield hovered around 1.125 percent Tuesday after having declined to 1.055 percent on July 1, the lowest level since August 2003. It fell to a record 0.43 percent in June of that year.

The BOJ may agree to extend the term of a credit program introduced in December or boost debt purchases should concern about a second global recession push the Nikkei 225 stock average below 9,000 and the yen stronger than 85 per dollar, Kato said.

That may happen in a few months and push 10-year yields below 1 percent, he said. If yields stay below that key psychological level, they may extend declines as they did in 2003, Kato said.

“I won’t be surprised if yields plunge to the 2003 level,” Kato said. “There are increasing elements that may cause a bubble. I see more buying factors for bonds, compared with 2003.”

If yields decline to 1 percent by Sept. 30 as Kato projects, investors who buy Tuesday would make a return of 1.3 percent, according to data compiled by Bloomberg.

The BOJ will keep its benchmark rate at 0.1 percent at the end of its meeting Thursday, according to all 19 economists in a survey. The central bank has left borrowing costs at that level since December 2008.

The BOJ buys ¥1.8 trillion in government bonds from lenders each month. It unveiled in December a ¥10 trillion program to offer three-month loans at an interest rate of 0.1 percent, that it later doubled to ¥20 trillion. In June, BOJ Gov. Masaaki Shirakawa and the Policy Board introduced a ¥3 trillion program to encourage lending to businesses.

Lingering concern about Europe’s fiscal problems and a slowdown in the U.S. economy will spur Japanese investors to put their cash into government securities, Kato said. That trend was apparent Monday, when bonds advanced after the DPJ’s defeat, he said.

Prime Minister Naoto Kan campaigned on a pledge to rein in the world’s largest public debt by raising the consumption tax and cutting spending.

“Yields could have gone up as the DPJ’s worse than expected defeat meant fiscal rehabilitation plans are set to stall,” Kato said. “Instead, the market showed how much the cautious outlook for the global economy continued to support bonds.”

The DPJ won 44 seats in the election, losing some of the 54 it had at stake, according to results compiled by NHK. The coalition government’s lack of a majority will force it to negotiate with smaller groups to pass legislation.

“Minority parties agree on one thing: the BOJ should do more,” Kato said. “That means pressure will increase for the BOJ to keep monetary easing for a longer time or act toward more easing.”

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