European Notes Rise for Fourth Week on Signs Slump Is Deepening

By Kim-Mai Cutler

Jan. 10 (Bloomberg) -- European government notes rose for a fourth straight week on signs the recession in the euro region is worsening, giving policy makers more scope to lower interest rates.

The gains pushed the two-year yield to its lowest level in at least 18 years as a government report yesterday showed German industrial production dropped for a third month in November. Bundesbank President Axel Weber signaled Germany’s economy may contract by more than the central bank previously forecast, spurring investors to buy the safest of assets.

“The risk appetite we saw at the beginning of the year is starting to fade,” said Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt. “Yields are near historic lows.”

The yield on the German two-year note fell eight basis points to 1.51 percent by 4 p.m. in London yesterday, bringing its decline this past week to 22 basis points. It dropped to 1.498 percent, the lowest since at least September 1990. The price of the 2.25 percent security due December 2010 rose 0.15, or 1.5 euros per 1,000-euro ($1,357) face amount, to 101.38.

The 10-year yield declined 11 basis points yesterday to 3.02 percent, leaving it six basis points higher over the past week. Yields move inversely to bond prices.

Bonds stayed higher after a U.S. government report yesterday showed the economy lost more than half a million jobs last month. The Labor Department said payrolls shrank by 524,000 jobs in December, while the unemployment rate rose to 7.2 percent, from 6.8 percent in November.

Yield Spread Widens

Demand for fixed income was also fueled as equity markets in the region slipped for a third time yesterday.

The spread, or difference in yield, between two- and 10-year notes widened to 1.52 percentage points, the most since September 2004, on expectations the European Central Bank will lower borrowing costs next week. The median of 58 economists surveyed by Bloomberg predict the ECB will cut its benchmark rate by half a percentage point to 2 percent on Jan. 15.

“The final quarter of 2008 may have been worse than we expected,” Weber said in the text of a speech delivered in Cologne on Jan. 8. “This would weigh on our growth projections for the current year.”

European retail sales fell 1.5 percent in November from a year-earlier, the European Union’s statistics office in Luxembourg said yesterday.

Ten-year bunds fell in the week on concern debt is flooding the market as governments look to fund bank bailouts and economic stimulus packages. Euro-region governments will issue about 20 billion euros of bonds every week during the first quarter, from a weekly average of 10-to-15 billion over the past two years, according to Societe Generale SA.

German bonds have lost investors 0.7 percent this year, compared with losses of 1.6 percent for gilts and 1.1 percent for U.S. Treasuries, according to Merrill Lynch & Co.’s German Federal Governments, U.K. Gilts and U.S. Treasury Master indexes.

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