* Benchmark yield hits 1-1/2-year high before easing back slightly
* 10-yr sale draws tepid demand amid lingering market volatility (Updates throughout)
By Shinichi Saoshiro
TOKYO, Aug 2 (Reuters) - Japanese government bond yields remained near 1-1/2-year highs on Thursday after an auction for 10-year bonds drew tepid demand as investors were wary about how much yields might rise under the central bank’s recent policy changes.
The 10-year JGB yield was 1 basis point lower at 0.115 percent but was just shy of 0.145 percent, which is hit earlier in the session, its highest since February 2017.
JGB yields have spiked this week after the Bank on Japan (BOJ) on Tuesday pledged to keep interest rates low for an extended period, but also suggested that it will allow rates to rise further than it previously allowed under its yield-curve control (YCC) scheme.
The seemingly mixed message has prompted the bond market to test the BOJ’s new commitment by pushing yields higher, to see at which level the central bank would step in through its so-called special JGB-buying operations.
The BOJ said it would now allow long-term yields to move 0.2 percentage point on either side of its zero percent target to improve functions in the government bond market.
Prior to Tuesday’s policy tweaks, seen to be made as the central bank tries to make its accommodative policy more sustainable, the market had considered 0.11 percent on the 10-year yield as the BOJ’s line in the sand.
The central bank on Thursday offered to buy 400 billion yen of five- to 10-year JGBs in an unplanned operation, helping cap the rise in yields.
However, it is yet to conduct a special JGB buying operation, at which it usually offers to buy an unlimited amount of debt at a certain yield level.
“Opinions vary widely regarding the level at which the BOJ might step in to stop the 10-year yield rise,” said Keiko Onogi, senior JGB strategist at Daiwa Securities.
“Some think it could be around 0.15 percent while others reckon it won’t intervene until 0.20 percent - and the market will stay volatile as long as different opinions exist.”
SUBDUED 10-YEAR AUCTION
Thursday’s 2.2 trillion yen ($19.72 billion) 10-year JGB auction showed that investors were cautious about buying new debt following this week’s volatility.
The bid-to-cover ratio, a gauge of demand at the auction, fell to 4.17 from 4.37 at the previous sale last month.
The tail, the difference between the lowest and average accepted price at the auction, widened to 0.12 yen from 0.02 yen and also pointed to lacklustre demand.
“The auction results were weak, with bidding seemingly done cautiously with the market having become volatile after the BOJ meeting,” Onogi at Daiwa said.
While the rise in long-term JGB yields was capped for the time being, super long bonds remained jittery. The 30-year yield was up 2.5 basis points at 0.830 percent after climbing to 0.835 percent, its highest since January.
($1 = 111.5600 yen)
Editing by Sherry Jacob-Phillips and Sam Holmes