European 10-Year Bonds Rise for Fifth Week as Slowdown Deepens

By Matthew Brown

Dec. 6 (Bloomberg) -- European government bonds rose for a fifth week as the region’s central bank president said the 15- nation economy will continue to contract into next year as the turmoil in global financial markets persists.

The gains pushed 10-year German bund yields to the lowest level in almost two decades as data showed the economy shrank in the second quarter and German factory output slumped for a second month in October. “Global and euro-area demand are likely to be dampened for a protracted period of time,” European Central Bank President Jean-Claude Trichet said after a 75 basis-point cut to 2.50 percent on Dec. 4.

“The risks to growth are very much on the downside, with inflation expectations diminishing rapidly,” said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets. “The ECB has further rate cuts in store and in this environment investors really have no other assets to buy. Bond yields will continue to fall.”

The yield on the bund, Europe’s benchmark government security, fell seven basis points to 3.02 percent by 4 p.m. in London yesterday. It slipped to 2.94 percent on Dec. 4, the lowest level since at least January 1989, when Bloomberg began collecting data on the security. The yield dropped 23 basis points in the week. The 3.75 percent bond due January 2019 rose 2.04, or 20.4 euros per 1,000-euro ($1,267) face amount, to 106.23.

The yield on the two-year note declined 12 basis points to 2.07 percent Yields move inversely to bond prices.

Flight-to-Safety

Bonds also gained as stock-market losses and a rise in the cost of insuring corporate debt to a record fueled demand for the safest assets. Equity markets in Europe yesterday extended the week’s losses after a report showed U.S. employers cut jobs last month at the fastest pace in a quarter century. The Dow Jones Stoxx 600 Index of stocks fell more than 8 percent.

Factory orders in Europe’s largest economy, adjusted for seasonal swings and inflation, fell 6.1 percent from September, when they dropped 8.3 percent, the Economy Ministry in Berlin said yesterday. Economists expected a decline of 0.5 percent, the median of 39 forecasts in a Bloomberg survey showed.

Investors should favor 10-year bonds, most sensitive to the outlook for price growth, Stamenkovic said. The yield will drop to 2.75 percent in the coming three months, he predicted.

Inflation will move “in line with price stability over the relevant policy horizon,” Trichet said at a briefing in Brussels after the rate decision.

‘Inflation is Falling’

“We cut interest rates because inflation is falling, which is positive,” fellow policy maker Lorenzo Bini Smaghi told Italy’s RAI broadcaster on Dec. 4. “This cut is in line with falling inflation, which is restoring consumer buying power.”

Bonds surged this year as the U.S. housing slump pushed up the cost of credit globally, causing stocks to tumble. The world’s largest financial companies incurred almost $1 trillion in writedowns and losses since the start of 2007. The recession in Europe’s 15-nation economy is its first in 15 years.

European services shrank at a record pace and retail sales fell more than forecast in November, reports showed Dec. 3. Unemployment in France, the second-largest economy using the euro, rose for the first time in more than two years in the third quarter, Insee, the country’s statistics office, said yesterday.

European bonds handed investors an 8.8 percent return this year, including 3.8 percent in November, the most since at least 1986, according to Merrill Lynch & Co.’s EMU Direct Government index. U.K. gilts paid investors 10.4 percent, while U.S. Treasuries returned 12.3 percent, Merrill indexes showed.

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.netMatthew Brown in London on mbrown42@bloomberg.net