GLOBAL MARKETS-Government bonds fall sharply as inflation lurks

                                
 (Updates prices, adds European outlook)
                                
 By Kevin Plumberg
                                
 HONG KONG, May 23 (Reuters) - Japanese government bond
prices dropped on Friday, pushing yields to their highest in
nine months, after fears of rising inflation pummelled U.S.
Treasuries despite a slight dip in oil prices from record
highs.
                                
 Japan's Nikkei share average <.N225> finished 0.2 percent
higher, boosted by demand for sectors that perform well during
periods of economic sluggishness but was down 1.5 percent on
the week.
                                
 Other Asia-Pacific stocks declined for a fourth day
running, shedding 0.9 percent according to the MSCI index
<.MIAPJ0000PUS>, while European markets were set to open little
changed.
                                
 Oil prices rose above $131 a barrel, off a record high
above $135 on Thursday but still up nearly 4 percent on the
week, stoking fears that energy costs could cut consumer demand
and choke business investment.
                                
 Worries that inflation pressures around the world will
continue to build and increase the potential for tighter
monetary policy hurt government bonds.
                                
 "Finally, after 10-15 years, the inflation threat is here.
This is something we haven't experienced in quite some time.
It's an X factor. So people are very cautious about fixed
income overall," said Naruki Nakamura, a portfolio manager who
oversees about 400 billion yen in Japanese government debt at
Fischer Francis Trees & Watts.
                                
 Growing expectations that the U.S. Federal Reserve may have
to raise interest rates to fight price pressures clobbered U.S.
Treasuries, helping to propel the benchmark 10-year Japanese
government bond yield <JP10YTN=JBTC> to the highest since
August 2007.
                                
 The benchmark 10-year Japanese government bond yield, which
moves inversely to price, climbed 8 basis points to 1.74
percent after jumping as much as 10 basis points at one stage.
                                
 U.S. 10-year Treasury yields <US10YT=RR> added to
Wednesday's 11 basis point pop, rising to 3.94 percent.
                                
 Euro zone government bond futures dipped, with the June
10-year bond future <FGLBc1> at the lowest since December 2007,
ahead of manufacturing data due later in the session.
                                
 VOLATILE BONDS
                                
 The bond market has been volatile as investors who had bet
on higher prices during the brunt of the credit crisis unwind
those positions. Also, despite the slight fall in oil prices,
central banks around the world have made clear that inflation
is their main focus, making higher interest rates likely.
                                
 "An increase in risk-seeking coupled with rising inflation
and inflation expectations represents a perfect storm for
nominal bonds, whether or not they have the stamp of the U.S.
Treasury. They are one asset you definitely dont want to hold
in such an environment," analysts with State Street Global
Markets said in a research note.
                                
 U.S. light crude prices <CLc1> rose 68 cents to $131.49,
having fallen more than 3 percent the previous session.
                                
 Many analysts believe it is inevitable oil prices will
continue to climb because of the large amount of speculation
and insatiable demand from developing economies, such as China.
                                
 "Oil would not be at $130 a barrel without China's roaring
economy and voracious appetite for energy of all types,
including oil. If China keeps growing, as we expect, upward
pressure on oil prices will persist," said Donald Straszheim,
vice chairman and economist with Roth Capital Partners in Los
Angeles.
                                
 Energy and resource stocks weighed in Australia <.AXJO> as
oil and commodity prices dipped, sending the index down 1
percent.
                                
 Hong Kong's Hang Seng index <.HSI> fell 0.9 percent and
Taiwan's TAIEX index <.TWII> was one of the biggest decliners
in the Asia-Pacific region, down 1.9 percent.
                                
 The drugs sector provided the biggest lift to Japan's
Nikkei share average <.N225>, which rose 33.7 points to
14,012.20, after Roche Holding AG <ROG.VX> said it would
increase its stake in Chugai Pharmaceutical Co Ltd <4519.T>.
However, the broader TOPIX <.TOPX> ended down 0.2 percent, or 3
points, to 1376.69.
                                
 The U.S. dollar steadied as oil prices eased, but the
currency stayed in sight of a one-month low against the euro on
worries that inflation could lead to a deeper U.S. slowdown.
The dollar rose on Thursday, boosted by a surprise drop in U.S.
weekly initial jobless claims.
                                
 The euro was unchanged at $1.5730 <EUR=>, while the dollar
was flat at 104.07 yen <JPY=>.
                                
 Spot gold <XAU=> was down 0.3 percent at around $918.20 an
ounce.
 (Additional reporting by Eric Burroughs and Elaine Lies in
Tokyo; Editing by Lincoln Feast)