Nov. 5 (Bloomberg) -- European government bonds rose as regional stocks declined and traders raised bets policy makers will lower interest rates by at least a half-percentage point.

German two-year note yields held near the lowest level in more than three years after a report showed retail sales fell for a fourth month and as economists forecast that the European Central Bank will cut its main interest rate to 3.25 percent tomorrow. Bonds declined earlier after Chancellor Angela Merkel's Cabinet agreed on a stimulus package to unlock 50 billion euros ($65 billion) of investment.

``Very soft economic numbers and weaker stocks are allowing bonds to retake earlier losses,'' said Sean Maloney, a London- based fixed-income strategist for Nomura International Plc. ``The sell-off earlier was overdone as the market already knew about the stimulus package. Its impact on the budget deficit is not going to be as great as the headlines would suggest.''

The gains pushed the yield on the 10-year German bund, Europe's benchmark government security, 4 basis points lower to 3.77 percent as of 5:35 p.m. in London. The 4.25 percent security due July 2018 climbed 0.30, or 3 euros per 1,000-euro ($1,301) face amount, to 103.83. The two-year yield fell 2 basis points to 2.51 percent. It declined to a three-year low of 2.41 percent on Oct. 31.

All 54 economists in a Bloomberg survey forecast the ECB will trim the region's main refinancing rate 50 basis points tomorrow. A basis point is 0.01 percentage point.

Stocks Fall

Bunds also gained as European stocks retreated for the first time in seven days, sending the benchmark Dow Jones Stoxx 600 Index 2.3 percent lower.

European bonds were underpinned by concern that investors haven't seen the worst of the fallout from the global credit crisis. BNP Paribas SA, France's largest bank, said today third- quarter profit fell 56 percent. Carlsberg A/S, the Nordic region's largest brewer, cut its full-year earnings and sales forecast.

European retail sales dropped 1.6 percent in September from a year earlier, the European Union's statistics office in Luxembourg said today. A separate report showed services business contracted at a record pace in October.

The region's bonds outperformed Treasuries last month, handing investors a 0.9 percent return, compared with a loss of 0.1 percent for their U.S. counterparts, according to Merrill Lynch & Co.'s EMU Direct and Treasury Master indexes.

ECB board member Juergen Stark said policy makers are ready to use ``all instruments'' to fight the deepening crisis, the Financial Times Deutschland reported today. More German savings banks than first estimated may be involved in risky investments, the paper said, without saying where it got the information.

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

Last Updated: November 5, 2008 12:39 EST