European Notes Set for Biggest Gain in Three Weeks on Rate View

European two-year government notes headed for their biggest weekly advance in three on speculation credit-market turmoil will deter the European Central Bank from lifting interest rates to curb inflation.

The difference in yields, or spread, between two- and 10- year German bonds rose to the widest in a month as renewed concern that the collapse of the U.S. subprime market will hurt economic growth boosted demand for the safest assets. Industrial production in France, the euro-region's second-biggest economy, fell more than forecast in September, a report showed today.

``It's all been about the financial sector and there's been a lot of flight to quality,'' said Toby Nangle, head of global aggregate fixed income at Baring Investment Services Ltd. in London. ``Unless we get some respite from the bad news'' yields will continue to fall.

The yield on the two-year note has slipped 8 basis points this week to 3.86 percent by 9:25 a.m. in London, 2 points higher on the day. The price of the 4 percent note due September 2009 has risen 0.14, or 1.4 euros per 1,000-euro ($1,469) face amount, to 100.23.

The yield on the 10-year bund, Europe's benchmark government security, has fallen 4 basis points this week to 4.14 percent.

Bunds were further hurt as Morgan Stanley, Merrill Lynch & Co. and Citigroup Inc. this week said they lost money on securities linked with home loans to risky borrowers. Yields move inversely to bond prices.
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