By Anchalee Worrachate Dec. 17 (Bloomberg) -- European government bonds rose, pushing the two-year note yield to the lowest level in more than five years, after the Federal Reserve cut its target interest rate to near zero, fueling speculation euro-region policy makers speed up rate cuts. The gains pushed the yield on the 10-year note below 3 percent for the first time almost two weeks. Bonds climbed even as stocks in Asia rallied to a five-week high as the Fed said it will “employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” “The Fed’s move will keep bonds cheerful for a while,” said Russell Jones, the London-based head of fixed-income and currency research at RBC Capital Markets. “Other central banks may follow, and perhaps the next candidate will be the Bank of Japan. The European Central Bank will be dragged, kicking and screaming, into it.” The two-year yield slipped 15 basis points to 1.93 percent, the lowest level since June 2003, as of 9: 02 a.m. in London. The price of the 2.25 percent security due December 2010 climbed 0.29, or 2.90 euros per 1,000-euro face amount ($1,412), to 100.62. The yield on the 10-year bund, Europe’s benchmark government security, fell 14 basis points to 2.99 percent. The Fed cut its target rate for overnight loans to a range of zero to 0.25 percent and pledged to buy unlimited quantities of securities. Possible steps in coming months include financing for a new package to shore up the housing industry, and expanding a $200 billion program to undergird credit card and student loans. Trichet’s Views The MSCI Asia Pacific Index of stocks added 2.7 percent today and the dollar slipped to a 13-year low versus the yen. Bonds rose yesterday even after European Central Bank President Jean-Claude Trichet said there’s a limit to how far the bank can cut interest rates and signaled policy makers may pause in January. “We have to beware of being trapped at nominal rates that would be much too low,” Trichet said in Frankfurt in comments published yesterday. “It seems to me that it is certainly something we have in mind and we will have to examine that and reflect on that. But as you know, we never pre-commit.” German bonds returned 10.6 percent this year, compared with 9.8 percent for gilts and 13.7 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 45 percent. Crude oil fell 54 percent. Relative Value The yield difference, or spread, between two- and the 10- year notes narrowed to 104 basis points today, from 108 basis points at the start of the week, on speculation that central banks will try to keep long-term rates lower as further scope to reduce short-term interest rates remains limited. European bonds outperformed U.S. Treasuries, with the extra yield investors demand to hold two-year German notes instead of Treasuries narrowing to 125 basis points, from 143 basis points yesterday. The spread will “head below 100 basis-point level within the coming six weeks,” Wilson Chin, a fixed-income strategist at ING Groep NV in Amsterdam, said in a report today. The ECB reduced the region’s main refinancing rate by 175 basis points to 2.50 percent since early October in an attempt to lessen the fallout from the global financial crisis. The central bank will lower the rate to 2 percent by March, according to the median of 26 economist forecasts compiled by Bloomberg. To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net

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