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European two-year notes little changed before ECB rate decision

European two-year government notes are little changed before today’s meeting of the European Central Bank, at which its expected to raise its borrowing costs and keep open its options for a further rate increase.

The Frankfurt-based European Central Bank will lift rates to 3.75%, according to all 38 economists surveyed by Bloomberg News. Debt may drop for a fourth day on speculation ECB President Jean-Claude Trichet will signal further rate increases in 2007 at his briefing after the decision. Futures trading shows investors expect the ECB to lift raise rates to 4% this year. „The rate decision is a foregone conclusion for a hike,” said Orlando Green, a fixed-income strategist in London at Calyon. „If Trichet is pretty hawkish then the market should react negatively.”

The yield on the benchmark two-year note, which is most sensitive to interest-rate expectations, rose 1 basis point to 3.88% at 8:42 a.m. in London, the highest this month as a rally in shares crimped demand for the safest assets. The price of the 3.75% bond due December 2008 fell €0.02 or 20 euro cents per €1,000 ($1,312) face amount, to 99.77. Yields on 10-year bunds, more sensitive to inflation expectations, also rose 1 basis point to 3.92%.

The ECB has signaled it will raise its benchmark rate to 3.75% today, which would be the seventh increase since late 2005. Trichet said last month the central bank needs to show „strong vigilance” against wage increases and other risks to price stability. He has used the phrase before to signal rate increases are imminent. ECB officials including Nicholas Garganas and Axel Weber last week suggested the bank will keep raising its benchmark rate after the increase it flagged for this month.

 

The spread, or gap in yields, between benchmark two-year German bunds and similar-maturity Treasuries has narrowed to 68 basis points today from 75 a week ago, as investors bet the ECB will keep raising rates as the Federal Reserve keeps its on hold. „I’d rather be long in Treasuries than bunds,” said Patrick Perret-Green, chief strategist at Mizuho Capital Markets. A long position is a bet an asset price will gain in the future. Debt may also drop before a report that economists expect will show factory output in Germany, Europe’s largest economy, rose 0.4% in January.

The report is due at noon in Berlin. The yield on the three-month Euribor futures contract for September rose 2 basis points to 4.05% today, suggesting investors expect the ECB to raise interest rates beyond the March increase. The contract settles to a three-month interbank offered rate for the euro, which has averaged about 16 basis points above the ECB’s benchmark rate since 1999. (Bloomberg)