By Lukanyo Mnyanda Oct. 9 (Bloomberg) -- European government bonds dropped, pushing 10-year yields up from the lowest level in more than six months, as rallying stocks and coordinated interest-rate cuts around the world sapped demand for the safest assets. Ten-year German bunds led declines, falling with their U.S. counterparts after Treasury Secretary Henry Paulson yesterday signaled the government may invest in banks as it tries to resolve the deepening credit crisis. The European Central Bank, which cut its benchmark rate by half a point yesterday, loaned banks a record $100 billion for a day to ease market tensions. ECB President Jean-Claude Trichet declined to rule out more cuts. ``The moves today are largely because stock markets have found a bit of support,'' said Marc Ostwald, a fixed-income strategist in London at Monument Securities Ltd. ``There's room for optimism.'' The yield on the 10-year bund, Europe's benchmark government security, climbed as much as 14 basis points, the most since Sept. 19, and was at 3.89 percent by noon in London. The 4.25 percent note due July 2018 fell 0.71, or 7.1 euros per 1,000-euro ($1,376) face amount, to 102.85. The yield on the German two-year note rose 4 basis points to 3.08 percent by 10:18 a.m. in London. Yields move inversely to bond prices. Equity markets rebounded in Europe and Asia, with the benchmark Dow Jones Stoxx 600 Index advancing 1.2 percent and the MSCI Asia Pacific Index climbing 1 percent. U.S. stock-index futures also increased. Central Bank Action Central banks in South Korea, Taiwan and Hong Kong reduced borrowing costs today, a day after their counterparts in the U.S., Europe and China coordinated monetary easing to revive lending amid the global credit crisis. The difference in yield, or spread, between two- and 10-year notes increased 5 basis points to 81 basis points, the widest since February, signaling investors still prefer notes that mature soonest. The shorter-dated notes, more sensitive to the interest-rate outlook, yielded 21 basis points more than the bund as recently as June 6. The odds of a rate cut at the ECB's next meeting were 34 percent today, according to a Credit Suisse Group derivatives index. Policy makers ``will always do whatever is necessary,'' Trichet said yesterday, while refusing to say the rate cut was a one-off. Most of the Frankfurt-based ECB's loans to financial institutions today were allotted at a marginal rate of 5 percent, from 9.5 percent yesterday. Recession in Europe ECB executive board member Lorenzo Bini Smaghi said the euro-area economy may already be in a recession and the central bank will cut its growth forecast for next year, Il Sole 24 Ore reported, citing an interview. Inflation could fall toward the ECB's 2 percent ceiling next year, the Italian newspaper quoted Bini Smaghi as saying. The 15-nation economy shrank 0.2 percent in the three months through June, confirming a Sept. 3 estimate, the European Union's statistics office in Luxembourg said yesterday. The definition of a recession is two consecutive quarters of negative growth. ``The ECB will cut interest rates again before the end of the year and consequently the short-end will remain supported,'' said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets. Investors should ``shift to the two-year part of the curve in anticipation of more cuts.'' European bonds handed investors a 2.2 percent return since the end of September, while U.S. Treasuries returned 1 percent, according to Merrill Lynch & Co.'s EMU Direct Government and Treasury Master indexes. To contact the reporter on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net

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