June 8 (Bloomberg) -- Treasuries fell, driving yields on two-year notes to the biggest three-day advance since October, and money-market rates increased, on growing speculation central banks will start to raise borrowing costs by the end of the year.

The yield on the U.S. note maturing in May 2011 climbed five basis points to 1.34 percent as of 11:19 a.m. in London, extending its climb in the past three trading days to 43 basis points, the most since Oct. 10. Europe’s Dow Jones Stoxx 600 Index fell 1.2 percent after a three-month rally sent the gauge to the highest level relative to earnings since 2004. Futures on the Standard & Poor’s 500 Index slipped 1 percent.

Signs that the global economy is emerging from the deepest slump since World War II are fueling bets the Federal Reserve will raise its target interest rate by year-end, Fed fund futures show. U.S. retail sales rose 0.5 percent in May, the first increase in three months, economists surveyed by Bloomberg expect a government report to show June 11. Payrolls fell the least in eight months in May, the Labor Department said June 5.

“The market is building in quite an optimistic view for the future,” said John Stopford, who oversees about $12 billion as head of fixed income at Investec Asset Management Ltd. in London. “Rates will normalize at some point, although it’s unlikely we are going to see significant rate increases in the next six months.”

Libor Rises

The London interbank offered rate for three-month loans in dollars rose for a second day, climbing to 0.65 percent, the British Bankers’ Association said. The increase follows declines from 1.42 percent at the start of the year and as high as 4.82 percent on Oct. 10, after Lehman Brothers Holdings Inc. filed for bankruptcy and credit markets froze.

Europe’s Stoxx 600 retreated after closing last week with a valuation of 24.9 times the earnings of its companies, the most expensive since March 2004, data compiled by Bloomberg show. Raw-material producers fell 4.2 percent, the biggest decline among 19 industry groups. The index of basic-resource companies ended last week valued at 11 times earnings, the highest level since August 2008.

BHP Billiton Ltd., the world’s biggest mining company, dropped 5.2 percent to 1,474 pence as copper, lead and nickel retreated on the London Metal Exchange. Rio Tinto Group declined 4.7 percent to 2,859 pence.

Ireland Downgraded

Ireland’s credit rating was lowered by Standard & Poor’s for the second time in three months on the cost of bailing out the country’s banking industry. The rating was dropped to AA from AA+ with a “negative” outlook. Ireland lost the top AAA credit rating on March 30.

The difference in yield, or spread, between Irish and benchmark German 10-year government bonds jumped to 284 basis points on March 19, the most in 10 years, compared with an average of 22 basis points the previous decade. The difference today was 202 basis points, up from 200 at the end of last week.

Rising bond yields may stymie efforts by central banks to lower borrowing costs through asset purchases. Former Bank of England policy maker David Blanchflower, now a professor of economics at Dartmouth College in New Hampshire, said in a June 5 interview the central bank may expand its program of buying securities with newly created money.

Ten-year Treasury yields surged 131 basis points since March 18, when the Fed said it will start buying assets to lower consumer interest rates. Thirty-year fixed-rate mortgages jumped to 5.45 percent from 5.15 percent in the same period, according to Bankrate.com in North Palm Beach, Florida.

The difference in yield, or spread, between two- and 10- year notes narrowed two basis points to 252 basis points today. It widened to a record 281 basis points last week.

Dollar Under $1.39

The dollar rose against the euro, trading under $1.39 for the first time since May 28, as Fed funds futures showed a 31 percent likelihood that the central bank will lift its target rate to 0.5 percent at its September meeting, up from a 15 percent chance a week ago.

The three-month euro interest-rate futures contract for December settlement climbed 5 basis points to 1.56 percent, compared with the current borrowing cost of 1.27 percent. The corresponding contract in pounds jumped 9 basis points to 1.69 percent, versus the 1.26 percent banks currently charge each other for three-month loans.

The pound fell for a fourth day against the dollar and gilts declined as Prime Minister Gordon Brown confronted a second attempt to oust him following a drubbing in European Union parliamentary elections. The pound dropped to $1.5846 in London, from $1.5981 at the end of last week.

Micex Retreats

The Micex Index in Russia, the world’s biggest energy- exporting economy, fell for the first time in three days, slumping 3.1 percent as oil prices decreased. The MSCI Emerging Markets Index dropped the most in more than two weeks, declining 1.8 percent. Taiwan’s Taiex Index lost 3.3 percent as Credit Suisse Group AG advised selling the country’s shares.

Crude oil for July delivery fell $1.11, or 1.6 percent, to $67.33 a barrel on the New York Mercantile Exchange. Copper fell for a second day on the London Metal Exchange, declining 1.1 percent to $4,926 a metric ton. Nickel, zinc and lead also retreated.

Gold fell to its lowest in more than a week in London, declining as much 1.1 percent to $949.15 an ounce.

To contact the reporter on this story: Justin Carrigan in London at jcarrigan@bloomberg.net

Last Updated: June 8, 2009 06:58 EDT