TOKYO, March 31 (Reuters) - Japanese government bonds

(JGBs) rallied on Tuesday as demand increased at a sale of

two-year securities and markets assessed the central bank's

response to inflationary pressures from the Middle East crisis.

The benchmark 10-year JGB yield fell 1.5

basis points (bps) to 2.340% after reaching as high as 2.390% on

Monday, a level not seen since February 1999. The five-year

yield fell 1 bp to 1.770%. Yields move inversely

to bond prices.

The two-year yield, the one most sensitive to

Bank of Japan policy rates, was flat at 1.355% after last week

reaching 1.38%, the highest since May 1995. An auction of about

2.8 trillion yen ($17.53 billion) of the securities had a

bid-to-cover ratio, a measure of demand, of 3.54, an increase

from 3.32 at the previous sale.

Core consumer prices in Tokyo rose 1.7% in March from a year

earlier, data showed, staying below the BOJ's 2% target for a

second straight month as the effect of fuel subsidies offset

rising costs from a weak yen.

"Yields on U.S. and European bonds have been falling in

defiance of rising oil prices, suggesting that a recession in

the West is now being viewed as a realistic risk amid the

prolonged conflict," said Ataru Okumura, a senior strategist at

SMBC Nikko Securities.

"Since we cannot be certain that the Bank of Japan will

proceed with rate hikes at a rapid pace, medium-term JGBs are

likely to enter a period of consolidation for the time being."

The 20-year JGB yield slid 5 bps

to 3.255%. The 30-year yield sank 9 bps to 3.7%,

while the yield on the 40-year bond, Japan's

longest tenor, fell 9 bps to 3.94%.

Despite the easing of inflation in Tokyo, the central bank

will still likely go ahead with a rate hike in April, according

to Barclays analysts Naohiko Baba and Takashi Onoda.

"The BOJ remains focused on the impact of higher crude oil

prices on long-term inflation expectations, which are still on a

gradual upward trend," they said in a report.

($1 = 159.7300 yen)

(Reporting by Rocky Swift in Tokyo; Editing by Rashmi Aich and

Subhranshu Sahu)