By Anchalee Worrachate Dec. 12 (Bloomberg) -- European government bonds fell, capping the biggest weekly decline in seven years, on speculation the U.S. government will produce a public-spending package and bailout for automakers, preventing the country from sinking deeper into a recession. Bonds erased earlier gains after the Treasury said it’s ready to provide financing to car producers after the Senate yesterday failed to approve a rescue plan. President-elect Barack Obama said Dec. 8 his government will invest the most in the nation’s infrastructure since President Dwight D. Eisenhower created the interstate highway system 50 years ago. “These pledges appear to reduce some of the downside risks to the economy, and are therefore bond negative,” said Harvinder Sian, a senior bond strategist at Royal Bank of Scotland Group Plc in London. “But their impact on bonds could be short-lived. You have economic data and an inflation outlook that are increasingly bond bullish. It’s inevitable that yields will come crashing in at some point in the first quarter.” The yield on the 10-year note rose 26 basis points from last week to 3.30 percent as of 4:56 p.m. in London, the most since the week ended Dec. 7, 2001. It climbed seven basis points on the day, after falling to as low as 3.09 earlier. The 3.75 percent note due January 2019 fell 0.64, or 6.4 euros per 1,000- euro ($1,334) face amount, to 103.91. The yield on the two-year note rose 23 basis points from last week, the most since the week ended June 6. Annual Returns German bonds returned 10.4 percent this year, compared with 8.3 percent for gilts and 12.2 percent for U.S. Treasuries, according to Merrill Lynch & Co.’s German Federal Government, U.K. Gilts and U.S. Treasury Master indexes. By comparison, the Dow Jones Stoxx 600 Index slid 46 percent and Germany’s DAX Index lost 42 percent. Crude oil declined 54 percent and gold 1.8 percent. “Because Congress failed to act, we will stand ready to prevent an imminent failure until Congress reconvenes and acts to address the long-term viability of the industry,” Treasury spokeswoman Brookly McLaughlin said in an e-mailed statement. The Treasury committed all but about $15 billion of the first half of the Troubled Asset Relief Program’s funds since the plan was enacted Oct. 3. Treasury Secretary Henry Paulson has resisted calls to use the program to aid the automakers. Corporate Default Risk Government bonds around the world advanced earlier as stocks declined and the cost of protecting European corporate bonds from default rose following the Senate’s rejection of the rescue program. Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 63 basis points to 1,100, according to JPMorgan Chase & Co. The index is a benchmark for the cost of protecting bonds against default and a decrease indicates an improvement in the perception of credit quality; an increase signals the opposite. Germany’s DAX Index dropped 2.2 percent. The Standard & Poor’s 500 Index slid 1.4 percent. Bonds also fell as European Central Bank council member Axel Weber cautioned against cutting the region’s key interest rate below 2 percent. A week after reducing the rate by 75 basis points, the biggest cut in the ECB’s history, officials are displaying little appetite to follow the Federal Reserve and other central banks in continuing to ease monetary policy. The ECB pared its key rate by 175 basis points since early October to 2.5 percent. Yield Spread “We should be cautious when our rates approach territory we haven’t expected before,” Weber said in an interview with Germany’s Boersen-Zeitung. “Our lowest level so far was 2 percent.” The difference in yield, or spread, between two- and 10- year notes was at 102 basis points, from 101 basis points yesterday and 98 basis points last week. The so-called steepening of the yield curve that suggested investors remained convinced the economy will deteriorate and the central bank will need to cut borrowing costs. Italy sold about 3.7 billion euros of bonds due in 2012, 2014 and 2023. The securities were sold at average yields of 3.82 percent, 4.11 percent and 5.02 percent respectively. Investor demand for the safest and most tradable government debt created unprecedented disparities in Europe’s bond market this year. Italian 10-year notes yielded 133 basis points more than the German debt of similar maturity today, matching the most since the euro’s 1999 debut. Dutch bonds yielded 61 basis points more than German bunds. German and Dutch debt carries the top AAA ratings at Moody’s Investors Service and Standard & Poor’s. Italy’s bonds are rated two steps below the top grade at Aa2 by Moody’s and four levels below the highest grade at A+ by S&P. To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net

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