Japan 20-year bond auction sets up early test of PM Takaichi's tax cut pledge

By Rocky Swift

TOKYO, Jan 20 (Reuters) - A sale of long-term Japanese government bonds (JGBs) on Tuesday will provide an early test by the markets of Prime Minister Sanae Takaichi's election campaign pledge to cut taxes.

Short- and long-term JGB yields surged to record highs on Monday on concerns that tax cuts, touted by both Takaichi's ruling Liberal Democratic Party and opposition groups, will worsen the government's already strained finances.

The Ministry of Finance will sell about 800 billion yen ($5.06 billion) in 20-year debt on Tuesday. Yields on the securities soared 9.5 basis points to a record close of 3.255% on Monday.

The yield JP20YTN=JBTC shot up further in early trading on Tuesday, climbing 4 basis points (bps) to an all-time intraday high of 3.295%. The benchmark 10-year JGB yield JP10YTN=JBTC rose 3 bps to 2.3%, the highest since February 1999.

"The 20-year bond auction at this time will see a severe outcome," said Katsutoshi Inadome, senior strategist at Sumitomo Mitsui Trust Asset Management. "It takes place as concerns grow about Japan's worsening fiscal health."

After more than a week of speculation, Takaichi on Monday made official her calling of a snap election on February 8 and pledged to suspend the nation's 8% sales tax on food for two years.

Pausing the food sales levy would reduce government revenue by an estimated 5 trillion yen a year, according to government data, roughly equivalent to Japan's annual spending on education.

Long-term JGB yields have risen sharply since early November, hitting successive record highs, amid concerns about the scale of Takaichi's fiscal stimulus. Short-term yields have come under upward pressure since the Bank of Japan raised its key policy rate in December and signalled more hikes were on the way.

The BOJ is widely expected to keep rates unchanged at the close of its meeting on Friday. But some central bank policymakers see scope to raise interest rates sooner than markets expect to contend with the weak yen, sources have told Reuters.

($1 = 158.2100 yen)