European Notes Post Nine-Week Gain as ECB Signals Lower Rates

By Gavin Finch

Nov. 22 (Bloomberg) -- European two-year government notes rose for a ninth week, the longest run on record, as stocks slumped and regional policy makers signaled further interest rates cuts to revive the recession-mired economy.

The gains pushed the yield on the note to the lowest level since July 2005 as the Dow Jones Stoxx 600 Index declined for a third week, stoking investor appetite for the safest assets. European Central Bank council member Axel Weber said yesterday the economic outlook is worsening ``rapidly,'' giving the bank room to lower rates further. Switzerland's central bank cut its target rate by one percentage point on Nov. 20 to spur growth.

``We're running out of superlatives to describe this market, but we live in unprecedented times,'' said Charles Diebel, head of European interest-rate strategy at Nomura International Plc in London. ``The recessionary deflation theme now looks to be accepted as the most likely outcome. There is still plenty of room to extend the bull move.''

The yield on the two-year note fell 14 basis points in the week to 2.08 percent by 3:30 p.m. in London yesterday. It slipped to 1.99 percent on Nov. 20, the lowest level since July 2005. The 4 percent security due September 2010 rose 0.20, or 2 euros per 1,000-euro ($1,261) face amount, to 103.32.

The yield on the 10-year bund, Europe's benchmark government security, declined 27 basis points to 3.40 percent this past week. Yields move inversely to bond prices.

Bonds rallied Nov. 20 after a government report showed German producer-price inflation slowed to 7.8 percent in October, from 8.3 percent in the prior month. Prices were unchanged, from an increase of 0.3 percent in September.

`Further Easing'

``Owing to a remarkable decline in inflationary pressures in the medium term and rapidly deteriorating economic prospects, euro-area monetary policy, in my view, has enough leeway for further easing if necessary,'' Weber said at a banking conference in Frankfurt yesterday.

Europe's manufacturing and service industries contracted in November at the fastest pace in at least a decade, according to an industry survey released yesterday.

The Frankfurt-based ECB lowered its key rate by half a percentage point to 3.25 percent on Nov. 6. The next rate-setting meeting is scheduled for Dec. 4.

Traders raised bets the central bank would cut rates again this year after the Swiss National Bank unexpectedly cut its target for the three-month Libor to 1 percent. The yield on the December interest-rate futures contract fell 24 basis points in the week to 3.36 percent yesterday.

Tumbling stocks worldwide and the prospect of the worst economic slump since the Great Depression is fueling demand for the safest assets. The German two-year note yield is within a quarter point of the lowest level since at least 1990, when Bloomberg began collecting the data. The yield on the two-year U.S. Treasury note fell to a record low on Nov. 20, while the three-month bill yield plunged to the weakest since 1945.

The MSCI World Index lost 11 percent in the week, while the Standard and Poor's 500 Index dropped from Nov. 14.

Returns on European bonds lagged behind those on Treasuries since September, handing investors a 4.2 percent gain, compared with 4.5 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: Gavin Finch in London at gfinch@bloomberg.net