Business

Tue Jun 10 01:46:03 PDT 2008

* Government bonds drop on Bernanke inflation warning

* U.S. dollar hits three-month high against yen

* Asia stocks slip with eyes on inflation, financials

By Kevin Plumberg

HONG KONG, June 10 (Reuters) – Government bond prices plunged and the U.S. dollar rose to a three-month high against the yen on Tuesday after a stark inflation warning from Federal Reserve chairman Ben Bernanke increased expectations that U.S. interest rates will rise.

The stronger dollar boosted shares in some Japanese exporters, but most Asian stock markets were knocked back by persistent concerns about inflation after oil hit a fresh record on Friday close to $140 a barrel.

UK stocks are expected to open about 0.4 percent lower, according to financial bookmakers, while equity futures in Germany and France were also pointing to a lower open.

Japan’s Nikkei share average ended 1.1 percent lower, while Asia-Pacific shares outside of Japan dropped 2.3 percent to a two-month low, an MSCI index showed

Financial shares were again among the worst-performing sectors, dragged down after Lehman Brothers on Monday forecast a $2.8 billion second-quarter loss and unveiled a plan to raise $6 billion to strengthen its capital.

The recent jump in oil prices has raised the chance that inflation could sail higher and the Fed will "strongly resist" public expectations for longer-term price pressures becoming permanent, Bernanke said in a speech.

His remarks pushed the benchmark 2-year U.S. Treasury yield, the most sensitive to monetary policy, to a five-month high.

The 2-year Japanese government bond yield hit its highest level since early August as investors factored in a risk that other central banks might have to raise interest rates as well.

Bernanke’s comments followed sobering remarks from European Central Bank President Jean-Claude Trichet, who jolted markets last week by suggesting euro zone rates could rise as early as July.

"Both the Bernanke and Trichet comments, whether by design or not, are occurring one after the other, and have the effect of tightening global liquidity while keeping dollar weakness capped. What happens with oil prices in this environment will be critical," said Ashley Davis, currency strategist with UBS in Singapore.

The 2-year U.S. Treasury yield, which moves inversely to the price, was at 2.9380 percent after jumping to a high of 2.9656 percent up from 2.7148 percent late on Monday.

The 10-year yield rose to 4.0640 percent from 4.0190 percent.

BOND MARKET VOLATILITY

The 10-year Japanese government bond yield rose 8.5 basis points on the day to 1.80 percent after earlier hitting 1.82 percent, its highest level since July 2007.

Besides Bernanke, other U.S. policymakers have stepped up their rhetoric to curb further weakness in the dollar, which is widely viewed as one of the reasons for oil’s doubling in price last year as international investors looked to buy cheaper U.S.-dollar denominated assets.

U.S. Treasury Secretary Henry Paulson said on Monday he would not rule out intervention in the currency market to keep the dollar from falling.

NOT A PRETTY PICTURE

By 0638 GMT, the dollar had jumped to around 106.77 yen near its highest level since February, as dealers watched the spread between U.S. bond yields and Japanese yields widen.

The euro was down 0.2 percent to $1.5585 well off an all-time high of $1.6018 reached in April.

The weaker yen helped boost shares of Japanese exporters like Nikon Corp and Olympus Corp

Australia’s S&P/ASX 200 index tumbled 2.8 percent, weighed by losses in the financial sector as investors feared banks may face more writedowns related to problems in global credit markets.

Hong Kong’s Hang Seng index fell 4.1 percent, catching up with other global markets after being shut for a holiday on Monday.

The Shanghai composite index dropped 8.5 percent, on track for its biggest single-day decline since June 2007, after China’s central bank over the long holiday weekend tightened bank reserve requirements by one percentage point, the most all year.

Bernanke’s inflation comments came after U.S. crude prices surged to a record high of $139.12 a barrel on Friday, rising nearly 9 percent on the day off the back of weakness in the dollar and Middle East tensions.

Rising oil prices, the dollar and inflation have become the focus of both Bernanke and Trichet, who have both radically altered expectations for interest rates in the span of a week.

Growing inflationary pressures have also weighed on shares, raising the prospect that emerging Asia-Pacific stocks could be stuck in a bear market.

From a record high on Nov. 1, the MSCI Asia ex-Japan index is now down 22 percent. The popular definition of a bear market is one characterised by a prolonged period of falling prices, usually by 20 percent or more.

"Inflation is still a big concern. These are not rosy times, that’s for sure," said Lucinda Chan, division director at Macquarie Equities.

U.S. light crude prices edged up 65 cents on the day at $135.00 a barrel and are up 41 percent since the year began.

(Additional reporting by Geraldine Chua in Sydney; Editing by Michael Urquhart)

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