European 2-Year Notes Post Seventh Weekly Gain as ECB Cuts Rate

By Kim-Mai Cutler

Nov. 8 (Bloomberg) -- European two-year government notes advanced for a seventh week, the longest sequence of gains in 12 years, after policy makers cut interest rates to head off a recession in the 15-nation economy.

The gains sent the two-year yield to the lowest level in three years after the European Central Bank lowered the main refinancing rate by half a point on Nov. 6 and the International Monetary Fund cut growth forecasts for the region. Industrial output in Germany, Europe's biggest economy, slipped the most since 1995.

``We are still in a crisis on a global scale,'' said David Schnautz, an interest-rate strategist in Frankfurt at Commerzbank AG, Germany's second-biggest lender. ``Central banks are all in easing mode so shorter-dated notes are the place to be.''

The yield on the two-year German note, most sensitive to interest-rate expectations, fell 14 basis points in the week to 2.4 percent. The 4 percent security due September 2010 climbed 0.19, or 1.9 euros per 1,000-euro ($1,275) face amount, to 102.79.

The yield on the German 10-year bund, Europe's benchmark government security, declined 20 basis points to 3.69 percent. Yields move inversely to bond prices.

Factory output fell an adjusted 3.6 percent from August, the Economy Ministry in Berlin said yesterday. Economists expected a decline of 1.7 percent, the median of 36 forecasts in a Bloomberg News survey showed. The outlook for production has ``dimmed markedly,'' the ministry said.

Weaker Growth

Central banks around the world are lowering borrowing costs to stave off the worst of the global banking crisis. The Bank of Korea cut its main rate for a third time in four weeks on Nov. 6 to prevent the economy entering a recession. Policy makers in the U.K., Switzerland and the Czech Republic trimmed their benchmark rates on the same day.

ECB President Jean-Claude Trichet said Nov. 6 momentum in the region's economy has ``weakened significantly.'' Policy makers reduced the benchmark rate to 3.25 percent, matching the forecasts of all but one of 55 economists surveyed by Bloomberg.

Further interest-rate reductions in the region are ``possible,'' ECB policy maker Erkki Liikanen told the Helsinki- based broadcaster MTV3 yesterday. French Finance Minister Christine Lagarde told France 3 national television last week the ECB's rate reduction was ``clearly not'' sufficient to boost the economy and that she expects a further cut by year-end.

The spread, or difference, in yield between two- and 10-year German notes was near the widest in four years at 1.3 percentage point, as traders bet interest rates will be cut further.

`Room to Maneuver'

``The ECB will decide in favor of more rate cuts in coming months,'' wrote Patrick Jacq, senior fixed-income strategist in Paris at BNP Paribas SA. ``At 3.25 percent, the ECB still has considerable room to maneuver,'' and at least 1 to 1.5 percentage points in rate cuts to deliver.

Jacq said the German yield spread may widen by at least a further 10 basis points.

Every Group of Seven economy except Canada will contract next year, the IMF said yesterday in an update to its World Economic Outlook report. Economic growth in the euro area will slump to just 0.1 percent, the worst performance since 1993, the Brussels-based European Commission forecast Nov. 3. The economy, which shrank in the three months through June, will probably continue to weaken in the third and fourth quarters, it said.

European bonds have outperformed Treasuries since September, handing investors a 2.3 percent return, compared with 1.3 percent for their U.S. counterparts, according to Merrill Lynch & Co.'s EMU Direct and Treasury Master indexes.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net