German government bonds advanced as a report showed European retail sales grew less than economists predicted, boosting demand for fixed income amid concern the economic recovery is floundering. The extra yield, or spread, investors demand to hold 10- year bunds instead of two-year notes was near the least since December as traders bet inflation will be contained. The European Central Bank will probably leave its main refinancing rate at a record low when policy makers meet on July 8, according to a Bloomberg survey. ECB President Jean-Claude Trichet yesterday pressed governments to trim their budget deficits. “Concerns regarding the double-dip or slow recovery have re-emerged,” said Michael Leister, a fixed-income strategist at WestLB AG in Dusseldorf. Investors are now worried “more with respect to growth rather than default or systemic risks. That should continue giving bunds a safe-haven bid,” he said. The 10-year yield fell four basis points to 2.54 percent as of 2:35 p.m. in London. The 3 percent security due July 2020 gained 0.33, or 3.3 euros per 1,000-euro ($1,255) face amount, to 103.98. The two-year yield declined three basis points to 0.63 percent. That left the spread between the securities at 191 basis points. It narrowed to 189 basis points on June 1, the least since Dec. 7. A flattening yield curve suggests greater demand for longer-dated securities, which are more sensitive to the outlook for inflation. Budget Deficits Retail sales in the 16 nations that share the euro rose 0.2 percent in May from the month earlier, the European Union’s statistics office in Luxembourg said today. Economists had expected a gain of 0.3 percent, the median of 19 estimates in a Bloomberg survey showed. In the year, sales rose 0.3 percent. Bunds gained even as investor sentiment unexpectedly improved. An index measuring sentiment in the 16-nation euro region this month advanced to minus 1.3 from minus 4.1, the Limburg, Germany-based Sentix research institute said today. The median prediction of seven economists surveyed by Bloomberg was for a decline to minus 5. German government bonds rallied this year as speculation that swelling budget deficits would cause countries such as Greece to default drove investors to the safest securities. Investors also bought the bonds amid speculation austerity measures in the region would hinder growth and prompt the ECB to keep rates unchanged. “We are in a period where we have to manage budgets very tightly,” Trichet told journalists in Aix-en-Provence, France yesterday. “I have no problem with austerity, rigor. I call this good budgetary management.” ‘Mood of Apprehension’ German bonds have returned 6.9 percent in 2010, compared with 5.7 percent for U.S. Treasuries, according to Bank of America Merrill Lynch indexes. The MSCI World Index of stocks has dropped 11 percent. “The overall mood is one of apprehension looking at the equity markets and bunds are rallying as a function of that,” said Toby Nangle, director of asset allocation at Baring Asset Management, which managed $46 billion at the end of May. Investors “appear to be judging an ugly contest with the decision about what’s worse. Bonds seem the least worse option,” he said. Greek government bonds gained, pushing the 10-year yield 21 basis points lower at 10.3 percent. The Portuguese 10-year yield declined seven basis points to 5.36 percent. ‘They Were Cheap’ Portugal’s government said last week it aimed to narrow its budget deficit faster than forecast previously and meet a European Union limit for a gap of 3 percent of gross domestic product in 2012, a year earlier than in a previous plan. French bonds rose as a report showed the country’s services expanded less than economists forecast and investors bet that a widening in the spread with Germany made the yields attractive. “They were cheap,” said Peter Chatwell, a London-based strategist at Credit Agricole CIB in London. “You get significantly higher returns but without creating too much risk for yourself” by investing in French rather than German debt, he said. The 10-year French bond yielded 38 basis points more than similar bunds, down from 56 basis points on June 8, the most since April 2009. The French 10-year yield decreased six basis points to 2.92 percent. Spanish 10-year bonds declined, leaving the spread with the German securities nine basis points wider at 203 basis points. Hidden Losses Spanish savings banks may be hiding losses on home loans by taking non-performing mortgages out of securitized transactions, according to CreditSights Inc. By carrying the bad loans on their own books the so-called cajas sidestep downgrades to their mortgage-backed securities, the independent bond research firm said in a report. The regional lenders helped fuel the nation’s real-estate bubble, which burst after the collapse of the U.S. subprime market. Spain hired banks to manage a 10-year syndicated bond issue, according to a banker involved in the sale. Barclays Capital, Banco Bilbao Vizcaya Argentaria SA, Caja Madrid, Credit Agricole, Deutsche Bank AG and Banco Santander SA will manage the sale, the banker said. To contact the reporter on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net

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