Sept. 7 (Bloomberg) -- Japan's two-year notes completed the biggest weekly gain in three as traders bet there is almost no chance the central bank will raise interest rates this month.

The European Central Bank left its refinancing rate at 4 percent yesterday, retreating from an increase signaled on Aug. 2 by President Jean-Claude Trichet. The odds the Bank of Japan will raise borrowing costs fell as low as 2 percent today from 37 percent at the start of last week, according to calculations by Credit Suisse Group using overnight interest-rate swaps.

``The two-year yields have come down because speculation of a September and October interest-rate hike has decreased extremely,'' said Hitomi Kimura, a bond strategist at JPMorgan Securities Japan Co. in Tokyo. ``Investors should keep risk exposure at the minimum.''

Two-year yields declined 5 basis points this week to 0.82 percent as of 3:02 p.m. at Japan Bond Trading Co., the nation's largest interdealer debt broker. The 10-year yield fell 1.5 basis points this week to 1.585 percent. A basis point is 0.01 percentage point. Yields move opposite to bond prices.

The economy probably contracted at a 0.7 percent annualized pace in the three months ended June 30, according to the median forecast of 30 economists surveyed by Bloomberg News. The Cabinet Office will release revised gross domestic product figures on Sept. 10.

`Too Low'

Gains in debt were tempered by speculation the decline of 40 basis points in 10-year yields since June will deter investors from buying the securities. Ten-year yields reached an 11-month high of 1.985 percent on June 13.

``The 1.6 level is already too low, so investors probably will not buy,'' said Genji Tsukatani, a Tokyo-based bond fund manager who helps oversee the equivalent of about $961 million at Schroder Investment Management Japan Ltd. in Tokyo. ``The 10- year bond may become more attractive at the 1.8 level.''

The extra yield investors receive from buying 10-year U.S. Treasuries instead of similar-maturity Japanese debt widened to about 2.9 percentage points from 2.85 percentage points on Sept. 5, the narrowest since March.

Bonds also gained as the Nikkei 225 Stock Average fell as much as 1.4 percent after U.S. foreclosures rose to a record.

Lenders began the process of seizing properties on 0.65 percent of U.S. mortgages in the second quarter, an all-time high, the Mortgage Bankers Association said yesterday. In the first quarter, that figure was 0.58 percent. The percentage of subprime, or higher risk, borrowers making late payments increased to 14.82 from 13.77 percent.

Japan's bonds often move in the opposite direction to stocks. Benchmark 10-year yields had a correlation of 0.86 with the Nikkei 225 in the past month, according to data compiled by Bloomberg. A value of 1 would mean the two moved in lock step.

Ten-year bond futures for September delivery rose 0.09 to 135.77 today in Tokyo.

To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net; Oliver Biggadike in Tokyo at obiggadike@bloomberg.net.

Last Updated: September 7, 2007 03:02 EDT