June 6 (Bloomberg) -- European stocks posted the biggest decline in more than two months on expectations the European Central Bank will keep raising interest rates.

E.ON AG and Iberdrola SA led a drop by utilities, while BNP Paribas SA and Spain's Banco Popular Espanol SA pushed banking shares lower. Thales SA, Europe's largest defense-electronics company, fell after Societe Generale SA downgraded the stock.

Mounting concern that borrowing costs will rise in the region helped halt a rally that sent the Dow Jones Stoxx 600 Index to within 6 points of a record. U.S. stocks slipped for the first time in a week yesterday after bond yields surged to a nine-month high amid signs the economy may be gaining momentum.

``We are in a period of rising interest rates and that obviously has an impact on the market,'' said Andrea Williams, a fund manager at Royal London Asset Management, where she helps manage about $2 billion.

The Stoxx 600 lost 1.7 percent to 390.07, the biggest decline since March 14. The index last dropped three days in a row during the final week of March. The Stoxx 50 slid 1.4 percent, while the Euro Stoxx 50, a measure for the 13 nations sharing the euro, sank 1.7 percent.

National benchmarks fell in all of the 17 western European markets that were open. The U.K.'s FTSE 100 declined 1.6 percent, France's CAC 40 slipped 1.5 percent and Germany's DAX tumbled 2.4 percent.

ECB Raises Rates

ECB policy makers, led by President Jean-Claude Trichet, raised the benchmark rate by a quarter-point to 4 percent today, the highest since August 2001. Trichet said at a press conference following the announcement that monetary policy remained on the ``accommodative side.'' He added that ``acting in a firm and timely manner to ensure price stability in the medium term is warranted.''

The Frankfurt-based bank will increase its key rate at least once more this year, a survey of economists shows.

E.ON, Germany's biggest utility, slid 3.1 percent to 116.41 euros. Iberdrola, Spain's second-biggest power company, slipped 4.1 percent to 42.51 euros. BNP Paribas, France's biggest bank, dropped 2.4 percent to 86.97 euros. Banco Popular, Spain's third- largest, lost 2.3 percent to 14.32 euros.

Higher borrowing costs make the dividends utilities pay less attractive relative to bond yields and reduce the value of debt held by banks.

Yields on U.S. two-year notes rose to 5 percent yesterday and those on the 10-year bond climbed to 4.99 percent, as a report showed service industries in the U.S. grew at the fastest pace since April 2006.

`Pose a Problem'

``The competition of bond yields is becoming consequential and if it continues can pose a problem'' for stocks, said Emmanuel Soupre, a Paris-based fund manager at Neuflize Gestion, which manages $15.6 billion.

Thales retreated 3.6 percent to 43.9 euros. Societe Generale cut its recommendation on the stock to ``sell'' from ``hold.'' The downgrade reflects ``a risk that the group's earnings quality could be diluted as a result of a merger with Safran,'' analysts at the bank wrote in a research note.

Sportingbet Plc sank 4 percent to 53.5 pence. The Web bookmaker that owns Paradise Poker reported a third-quarter loss after a U.S. crackdown on Internet gaming forced the company to sell units that took American wagers for $1.

Zodiac SA, the biggest supplier of seats and escape chutes for Airbus SAS aircraft, added 1 percent to 58.26 euros. Societe Generale raised its recommendation on the stock to ``buy'' from ``hold,'' citing positive momentum in the aerospace activities and speculation about consolidation in the industry.

Vodafone Group Plc, WPP Group Plc, Linde AG, Punch Taverns Plc, Wendel Investissement, Premier Foods Plc, Bellway Plc and Debenhams Plc all trade today without the right to their latest dividends.

To contact the reporter on this story: Adria Cimino in Paris at acimino1@bloomberg.net.

Last Updated: June 6, 2007 12:53 EDT