TOKYO, Oct 31 (Reuters) - Japanese bonds and bond futures fell sharply on Tuesday after the Bank of Japan tweaked its policy to say it would no longer aggressively cap yields, even while it kept policy targets unchanged and inflation estimates modest.
The 10-year JGB yield rose 6 basis points (bps) to its highest levels in a decade around 0.95% after BOJ's review. Yields had risen well ahead of the BOJ announcement as market speculation swirled of an imminent policy tweak.
Ten-year JGB futures slipped, last down 0.46 points.
Five-year yields hit 0.45%, their highest in 10 years.
As widely expected the BOJ maintained its -0.1% target for short-term interest rates and that for the 10-year government bond yield around 0% set under yield curve control (YCC).
But it re-defined its 1.0% cap as an "upper bound" with room for allowance, rather than a rigid cap.
"It (the new reference range) suggests they will allow yields to rise above 1%, while still trying to keep the changes to policy very subdued. Speculation of an eventual removal of the YCC will continue to build," said Charu Chanana, a market strategist at Saxo in Singapore.
The less-rigid cap on yields signalled another step in the BOJ's efforts to slowly dismantle its controversial yield-curve-control policy, which has been undermining the yen .
Investors however seemed nervous and reluctant to test 1% immediately, wary of how aggressive the BOJ will be about defending the level and managing the pace of any rise in yields.
Makoto Suzuki, a senior bond strategist at Okasan Securities, expects 10-year yields to move around 0.9%.
"I think for the time being that's about the level it's going to hover (at) until negative interest rate policy ends," he said. (Reporting by Junko Fujita and Brigid Riley; Editing by Vidya Ranganathan and Kim Coghill )
