May 28 (Bloomberg) -- European and Japanese government bonds fell, after Treasuries had their biggest rout in four months yesterday, on concern central bank efforts to revive the global economy by driving down borrowing costs are failing.

Stocks slid, with the MSCI World Index losing 0.8 percent as of 9 a.m. in New York, while futures on the Standard & Poor’s 500 Index rose 0.3 percent. Copper led declines in metals. The yen dropped the most in eight weeks against the dollar. The gap between two-year and 10-year Treasuries narrowed to 267 basis points from a record 276 basis points yesterday.

Yields on German bunds rose five basis points to 3.67 percent, near the highest level in six months. The yield on Japanese 10-year bonds climbed as much as three basis points to 1.5 percent, also the highest in at least six months. Ten-year Treasury yields rose to the highest level since November yesterday amid speculation record U.S. debt sales will offset the Federal Reserve’s attempts to lower consumer interest rates by buying assets. Treasuries rebounded in European trading.

“If yields stay around these levels or move higher then the mortgage market, and financing in the economy, could easily start to choke off the recovery,” Jim Reid, a strategist at Deutsche Bank AG in London, wrote in a research note today. “We will see who is more powerful, the markets or the Fed.”

The Dow Jones Stoxx 600 Index of European shares weakened for the first time this week, losing 1.2 percent as banks retreated, while the MSCI Asia Pacific Index fell 0.8 percent. The yen dropped 1.8 percent to 97.13 per dollar after a report showed growing demand for overseas assets among Japanese investors. Industrial metals declined on the London Metal Exchange, with copper falling 0.5 percent and tin slipping 0.4 percent.

Treasury Auction

The U.S. will sell $3.25 trillion of Treasuries in the fiscal year ending Sept. 30 to fund bank bailouts, stimulus spending and a record budget deficit, according to Goldman Sachs Group Inc. Today, the Treasury will auction $26 billion of seven-year notes.

Central banks and governments around the world have pledged more than $13 trillion to prop up the financial system during the first global recession since World War II, according to data compiled by Bloomberg.

Yesterday’s slump in U.S. government debt was triggered by rising yields on Fannie Mae and Freddie Mac mortgage bonds, which stoked concern that the Fed’s attempt to use lower home- loan rates to stem the housing slump and bolster consumer spending might falter.

Mortgage Rates

Mortgage bond yields are now higher than before the Fed announced March 18 it would expand purchases of those securities to drive down interest rates on new loans. Yields on Washington- based Fannie Mae’s current-coupon 30-year fixed-rate mortgage bonds climbed to 4.69 percent yesterday, the highest since Dec. 5 and up from 3.94 percent on May 20, Bloomberg data show.

The average rate on a 30-year U.S. mortgage increased eight basis points to 5.08 percent yesterday, according to bankrate.com. That’s 141 basis points higher than the 10-year Treasury yield, compared with 305 basis points at the start of the year.

Treasuries rallied today, paring yesterday’s drop and sending the yield on the 10-year note seven basis points lower to 3.67 percent. Ten-year Treasury yields increased 19 basis points yesterday, the most since Jan. 19.

“The bond market and its yield curve are telling you people are very skeptical about the quantitative easing,” said Robin Marshall, head of fixed income in London at Smith & Williamson Investment Management, which has $20 billion of assets. “The plan might work eventually, but it’s difficult to be accurate. The market is not sure about growth, but it seems to be certain that inflation will return.”

Bunds, JGBs

European government bonds dropped for a fifth day as Italy sold 8.8 billion euros ($12.2 billion) of debt, sending the yield on the benchmark German 10-year security to its highest since Nov. 17. Japan’s 10-year bonds dropped for a second day.

Yesterday’s slide in Treasuries left the 10-year yield higher than the equivalent German bund for the first time since March 10. The difference, or spread, with Japanese government bonds widened to 226 basis points, the most since November, according to Bloomberg data.

Rising mortgage rates threaten to choke off economic growth as credit markets recover. Bank of England policy maker David Blanchflower doubts the U.K. economy, Europe’s second-largest, will rebound before 2010, the London-based Times cited him as saying in an interview. The pound slid 0.5 percent to 87.11 pence per euro.

Euro Gains

The cost of borrowing between banks was little changed today. The London interbank offered rate, or Libor, that banks say they charge each other for three-month dollar loans stayed at about 0.67 percent, according to the British Bankers’ Association. It rose for the past two days.

The euro strengthened against the dollar amid growing expectations for a recovery in the 16-nation economy. The common currency rose 0.3 percent to $1.3865 after the European Commission in Brussels said an index of executive and consumer confidence climbed to the highest level in six months.

The yen declined 1.9 percent to 97.19 per dollar, its biggest drop since March 31, after Japan’s Ministry of Finance said the nation’s investors boosted purchases of foreign bonds last week to the highest level in a month.

The MSCI World Index of 23 developed markets has rebounded 37 percent since March 9. The rally drove the gauge’s valuation to 17.9 times the earnings of its 1,677 companies on May 26, the most expensive since 2004, data compiled by Bloomberg show.

Bank Stocks

Frankfurt-based Deutsche Bank AG, Germany’s biggest lender, fell 2.7 percent to 47.04 euros. London-based Barclays Plc, the U.K.’s third-largest bank, slipped 2.2 percent to 283.75 pence.

London-based Man Group Plc retreated 2.5 percent to 243.75 pence. The biggest publicly traded hedge-fund manager said annual pretax profit dropped 43 percent after assets under management declined by a third.

The decline in copper prices helped send London-based BHP Billiton Ltd., the world’s largest mining company, down 2.1 percent to 1,404 pence.

Futures on the Standard & Poor’s 500 Index added 0.3 percent before reports that may show orders for durable goods and sales of new houses improved in the U.S. last month.

General Motors Corp. slipped 7 percent to $1.07 in early U.S. trading. Negotiators in Berlin working through the night failed to finish the rescue of GM’s Opel unit after the Detroit- based automaker demanded an extra 300 million euros in cash. GM, facing a potential bankruptcy filing, asked for immediate assistance from the German government to keep Opel operating.

Asset Purchases

The Fed has purchased almost $131 billion in U.S. debt since March 25. Officials have also embarked on a plan to buy as much as $1.25 trillion in so-called agency mortgage-backed securities.

“If government bond yields continue to rise, we may see a negative impact on the price of corporate bonds and in turn a slowing in demand from investors,” said Willem Sels, head of credit strategy at Dresdner Kleinwort in London.

The extra yield investors demand to buy company bonds rather than government notes has narrowed every day for the past two weeks and is now 3.55 percentage points, down from a record 5.11 percentage points on March 30, according to Merrill Lynch & Co.’s Global Broad Market Corporate index.

In developing nations, the yield spread investors demand to own government bonds instead of U.S. Treasuries widened by 11 basis points to 4.50 percentage points, according to JPMorgan Chase & Co.’s EMBI+ Index.

Crude Slips

Crude oil for July delivery declined 29 cents to $63.74 a barrel on the New York Mercantile Exchange, before an OPEC decision on whether to change production levels. Saudi Arabia’s oil minister said yesterday the Organization of Petroleum Exporting Countries doesn’t need to cut production levels at its meeting in Vienna today.

“We don’t see substantial signs today that we will see better developments in the second half,” Svein Richard Brandtzaeg, chief executive officer of Norsk Hydro ASA, Europe’s third-largest aluminum producer, said in an interview.

To contact the reporters on this story: Anchalee Worrachate in London aworrachate9@bloomberg.net; Justin Carrigan in London at jcarrigan@bloomberg.net

Last Updated: May 28, 2009 09:12 EDT