Tokyo Market: Pessimism hits stock index

JAPAN'S benchmark stock index may fall to a 12-year low this week on pessimism the government can stabilise the country's fragile financial system in time to prevent speculative attacks on weakened banks. Bonds are likely to gain as investors expect an auction of 10-year government bonds to attract strong buying on the dim outlook for stocks.

The Nikkei 225 may sink as low as 13,500, a depth last tested in February 1986, as investors worry the ruling Liberal Democratic Party won't be able to secure rapid parliamentary approval of a plan to lighten the estimated Y77tn in bad and risk loans burdening the industry. Opposition groups last week rejected the most recent proposal, which leaves open the possibility of using taxpayer money to bail out floundering Long-Term Credit Bank of Japan.

"It's hard to imagine a breakthrough on banks - the opposition parties smell blood and want to force an election if possible," said Yoshio Inamura, at Tokyo-Mitsubishi Asset. "The deeper they dig in their heels, the greater the encouragement to target the next LTCB."

Banks were among the heaviest drags on the market last week as the Nikkei fell 1.8 per cent, to 13,723.84. Investors are bracing themselves for more external shocks such as the near-collapse of a US hedge fund, which has raised concerns about a financial crisis in the US. Shares in exporters such as Sony, Fuji Photo Film and Honda Motor could be vulnerable. Still, the heavyweights of the Nikkei will likely get a boost early in the week as foreign institutional investors buy shares to "dress up" their portfolios before the end of the month.

On Tuesday, The Ministry of Finance is expected to sell about Y1.4tn ($10.39 bn) of the bonds, Y200bn more than usual, which may have a record- low 0.9 per cent coupon.

"Even so, there'll be strong demand (at the auction) because investors have sold risky corporate bonds and bought government bonds," said Masahiro Inoue, a fund manager at Sumitomo Marine & Fire Insurances. "Cash can't go anywhere else except to bonds."

Last week, the benchmark government bond yield fell 1 basis point to 0.820 per cent. Bonds posted the biggest gain in a week on Friday as slumping stocks prompted a flight to the safety of fixed-income securities amid concern about global credit risk.