(Updates data, quotes, chart)
* U.S. Q4 2017 GDP grew 2.6 percent, below forecasts
* Two-year note yield hits nine-year high
* Bank of Japan governor sees signs of inflation
By Kate Duguid
NEW YORK, Jan 26 (Reuters) - U.S. Treasury yields rose Friday following data showing the nation's economy grew 2.6 percent in the final quarter of 2017 and the governor of the Bank of Japan said inflation is finally close to reaching its target.
Gross domestic product grew slower than the 3 percent increase forecast among economists polled by Reuters. Nevertheless, the market response was muted, with benchmark 10-year note yields falling within a basis point, before paring losses, suggesting investors remained confident in the underlying health of the economy and the Federal Reserve's plan to hike interest rates in March.
The GDP "number looked like a bit of a disappointment, but when you strip out trade and inventories you end up with GDP growth - excluding those two factors - that was well above 4 percent," said Brian Daingerfield, macro strategist at NatWest Markets in Stamford, Connecticut.
The advance estimate of GDP offered insight into the U.S. economy before President Donald Trump's tax cuts took effect. Trump has previously cited 3 percent growth as a target rate for the country.
The GDP number "should give Federal Reserve officials some cover to offer a stronger statement at the January FOMC next week," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.
Treasury yields also rose in afternoon trading after Bank of Japan Governor Haruhiko Kuroda said wages and prices were gradually rising, though there remained a number of factors preventing the central bank from reaching its 2 percent inflation target. Bond yields and inflation rates move in tandem, as investors require a higher yield to compensate for inflation risk.
Kuroda said the central bank would continue its policy of quantitative easing, citing challenges to the economy posed by globalization and a "tenacious" deflationary mindset. However, the Bank of Japan is the second-largest holder of Treasuries in the world and any suggestion of tightening monetary policy can spook markets.
"Even a modest hint from the Bank of Japan that they're turning slightly more constructive on inflation is notable given how sensitive the market is to the possibility that some of the world's most accommodative central banks are starting to change their mentality on the growth-inflation balance," said Daingerfield.
At 3:26 p.m. (2026 GMT), the yield on 10-year Treasury notes was 2.660 percent, above Thursday's close at 2.621 percent. The two-year note yield reached a high of 2.132, its highest since September 2008.
Friday, Jan. 26, at 1537 EST (2037 GMT):
Price US T BONDS MAR8 148-26/32-0-19/32 10YR TNotes MAR8 122-20/256 -0-92/256
PriceCurrentNet
YieldChange
(pct)(bps)Three-month bills 1.3975 1.4217 -0.005Six-month bills 1.6025 1.6377 0.003Two-year note 99-196/256 2.1203 0.036Three-year note 99-78/2562.2439 0.047Five-year note 99-142/256 2.4702 0.052Seven-year note 99-100/256 2.5958 0.04410-year note 96-128/256 2.6581 0.03730-year bond 96-220/256 2.9082 0.028
DOLLAR SWAP SPREADS
Last (bps) Net
Change
(bps)U.S. 2-year dollar swap18.00 0.00 spreadU.S. 3-year dollar swap18.00-0.50 spreadU.S. 5-year dollar swap 6.75-0.25 spreadU.S. 10-year dollar swap2.00 0.50 spreadU.S. 30-year dollar swap-14.75 1.00 spread
(Reporting by Richard Leong and Kate Duguid; Editing by Chizu Nomiyama and Meredith Mazzilli)
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