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Weak demand for two-year notes at auction raises concerns

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BOJ's Nakagawa warns of U.S. tariff policy impact

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Bonds demand boosted as PM Ishiba's position stabilises

(Adds auction details in paragraphs 2, 9 and 10, BOJ details in

paragraphs 6 and 7, updates yield levels)

By Rocky Swift and Junko Fujita

TOKYO, Aug 28 (Reuters) - Japanese government bonds

(JGBs) rallied on Thursday as yields at historic highs drew in

buyers and political pressure on the nation's fiscally

conservative prime minister appeared to ease.

Two-year notes pared gains after a debt auction showed the

weakest demand in almost 16 years.

Bond yields move inversely to prices.

JGBs have skidded in recent months on mounting concerns over

the government's debt levels and deficit spending. Selling

intensified after an electoral drubbing last month for the

political coalition of Prime Minister Shigeru Ishiba.

Ishiba insisted on staying on in the job, and domestic media

reports this week indicated that momentum was waning for an

early leadership vote within his Liberal Democratic Party (LDP).

"It looks more likely that the LDP won't bring forward its

presidential election," said Katsutoshi Inadome, senior

strategist at Sumitomo Mitsui Trust Asset Management.

Improving prospects for Ishiba prompted investors to swoop

in on recently pummelled 30-year bonds, he added, while dovish

comments from Bank of Japan board member Junko Nakagawa lifted

sentiment.

On Thursday, Nakagawa said persistent uncertainty stemming

from U.S. tariff policies could weigh on business and household

sentiment.

The 30-year JGB yield fell 4.5 basis points

(bps) to 3.185% from the previous session, when it touched an

unprecedented 3.35%.

The benchmark 10-year yield fell 0.5 bp to

1.62%, easing from Wednesday's peak of 1.63%, a 17-year high.

The 20-year yield fell 3 bps to 2.620%. The

two-year yield was flat at 0.86% after touching

0.845% earlier. A securities auction received bids worth 2.84

times the amount sold, the lowest ratio since September 2009.

"This does raise concerns about upcoming auctions in

general, namely the 10-year and 30-year, which have been

recording historical high yields," said Shoki Omori, chief desk

strategist at Mizuho Securities.