Nov. 7 (Bloomberg) -- European two-year government notes advanced for a seventh week, the longest sequence of gains in 12 years, as a report showed industrial production in Germany fell the most since 1995.

Two-year yields were near the lowest in three years a day after the European Central Bank lowered the main refinancing rate by half a point yesterday and as the U.S.'s National Bureau of Economic Research confirmed the world's largest economy is in recession. Factory output in Germany, Europe's biggest economy slipped 3.6 percent in September.

``We are still in a crisis on a global scale,'' said David Schnautz, an interest-rate strategist in Frankfurt at Commerzbank AG, Germany's second-biggest lender. ``Central banks are all in easing mode so shorter-dated notes are the place to be.''

The yield on the two-year German note, most sensitive to interest-rate expectations, fell 3 basis points to 2.40 percent by 4:25 p.m. in London, leaving it 14 basis points lower in the week and near the lowest closing level since September 2005. The 4 percent security due September 2010 climbed 0.05, or 50 euro cents per 1,000-euro ($1,275) face amount, to 102.82.

The yield on the German 10-year bund, Europe's benchmark government security, slid 3 basis points to 3.67 percent, a decline of 23 basis points in the past week. Yields move inversely to bond prices.

Factory output fell an adjusted 3.6 percent from August, the Economy Ministry in Berlin said today. Economists expected a decline of 1.7 percent, the median of 36 forecasts in a Bloomberg News survey showed. The outlook for production has ``dimmed markedly,'' the ministry said.

Weaker Growth

Central banks around the world are lowering borrowing costs to stave off the worst of the global banking crisis. The Bank of Korea cut its main rate for a third time in four weeks today to prevent the economy entering a recession. Policy makers in the U.K., Switzerland and the Czech Republic trimmed their benchmark rates yesterday.

ECB President Jean-Claude Trichet said yesterday momentum in the region's economy has ``weakened significantly.'' Policy makers reduced the benchmark rate to 3.25 percent, matching the forecasts of all but one of 55 economists surveyed by Bloomberg.

Further interest-rate reductions in the region are ``possible,'' ECB policy maker Erkki Liikanen told the Helsinki- based broadcaster MTV3 today. French Finance Minister Christine Lagarde told France 3 national television late yesterday the ECB's rate reduction was ``clearly not'' sufficient to boost the economy and that she expects a further cut by year-end.

ECB's Wellink

Inflation is ``still high'' and ``will most surely'' slow further, ECB policy maker Nout Wellink said in an interview with a magazine published by the Dutch central bank today.

The difference in yield, or spread, between two- and 10- year German notes was near the widest in four years at 1.29 percentage point as traders bet interest rates will be cut further.

``The ECB will decide in favor of more rate cuts in coming months,'' wrote Patrick Jacq, senior fixed-income strategist in Paris at BNP Paribas SA. ``At 3.25 percent, the ECB still has considerable room to maneuver,'' and at least 1 percentage point to 1.5 percentage points in rate cuts to deliver.

The German yield spread may widen by at least a further 10 basis points, he said.

Spain will guarantee bond sales by its banks for as long as five years under a 200 billion-euro ($256 billion) program to encourage lending, said three people with knowledge of the plan.

Spanish 10-year notes yielded 58 basis points more than bunds, down from 71 basis points a week ago.

G-7 Contracting

Every Group of Seven economy except Canada will contract next year, the IMF said yesterday in an update to its World Economic Outlook report. Economic growth in the euro area will slump to just 0.1 percent, the worst performance since 1993, the Brussels-based European Commission forecast Nov. 3. The economy, which shrank in the three months through June, will probably continue to weaken in the third and fourth quarters, it said.

European bonds have outperformed Treasuries since September, handing investors a 2.3 percent return, compared with 1.3 percent for their U.S. counterparts, according to Merrill Lynch & Co.'s EMU Direct and Treasury Master indexes.

The world's biggest economy is in recession, according to the leading economist for the National Bureau of Economic Research, a panel that dates economic cycles.

The U.S. unemployment rate rose to the highest level since 1994 as companies slashed payrolls, the Labor Department reported today. Goldman Sachs Group Inc. forecast the deepest U.S. contraction since the recession of 1982, with the economy shrinking 3.5 percent in this quarter and 2 percent in the first three months of 2009.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net

Last Updated: November 7, 2008 11:34 EST