French Yields Jump Most Since 2008 on Banks; German Bunds Drop

French bonds slumped, with 10-year yields rising the most since October 2008, amid speculation European nations will need to backstop their banks, placing an additional burden on state finances.

Ten-year French yields climbed 38 basis points this week, the most since the euro was introduced in 1999. The extra yield investors demand to hold 10-year French bonds instead of German bunds also expanded to the most since the euro started. Spain’s 10-year bonds fell for a fifth day after Standard & Poor’s cut the nation’s credit rating. Yields climbed across the euro area after European Central Bank President Jean-Claude Trichet said the ECB will not act as a “lender of last resort.”

“If you look at the AAA countries, France is a bit vulnerable on that front,” said Mohit Kumar, head of European interest-rate strategy at Deutsche Bank AG in London. Depending on the way bank balance sheets are firmed up, “there will be an impact on the sovereign and the economy,” he said

Ten-year French yields jumped 17 basis points to 3.13 percent at 4:27 p.m. London time, after rising as much as 18.6 basis points, the most since Oct. 31, 2008. The 3.25 percent securities due October 2021 dropped 1.485, or 14.85 euros per 1,000-euro ($1,386) face amount, to 101.025. The weekly increase in yield is the most since the period ended Oct. 9, 1998.

The yield premium of French bonds over benchmark German bunds expanded to as much as 94 basis points from 75 basis points at the end of last week.

AAA Nations

Bonds issued by other European AAA nations also slid. Ten-year Dutch yields increased nine basis points to 2.61 percent, Austrian rates rose 13 basis points to 3.09 percent, and German yields climbed nine basis points to 2.20 percent.

The ECB will not act as a lender of last resort to member states and the “ultimate backstop is, of course, the governments,” Trichet said in an interview with the Financial Times. “To do anything that would let governments off their responsibilities would be a recipe for failure,” he said.

As finance ministers and central bankers from the Group of 20 began a two-day meeting in Paris, European officials are moving closer to a crisis-fighting plan that may impose higher bank capital levels on the region’s lenders. The proposals may also include deeper losses for holders of Greek bonds as well as more support for bailouts and the International Monetary Fund.

Bank Losses

The Bloomberg Europe 500 Banks and Financial Services Index has slid by almost a third this year, paced by Dexia SA, the Franco-Belgian lender that’s being broken up with government support. The index fell yesterday as Credit Suisse AG analysts estimated lenders would need to raise about 220 billion euros of capital in stress tests that required a 9 percent core tier-one capital ratio rather than the 5 percent used in July.

“There are concerns about the banking sector and that extra liability with regard to recapitalization plans, and reports that sovereigns will have to recapitalize themselves,” said Orlando Green, a fixed-income strategist at Credit Agricole Corporate & Investment Bank in London. “That suggests finances in France and Belgium will remain strained for the foreseeable future.”

The eight largest U.S. money-market funds reduced their lending to French banks by 44 percent last month, according to filings compiled by Bloomberg and published in today’s Bloomberg Risk newsletter.

Spanish 10-year yields climbed four basis points to 5.24 percent, even after the ECB was said by people with knowledge of the deals to have bought the nation’s securities. S&P cut Spain’s ranking by one level to AA-, with the outlook remaining negative, the company said yesterday.

Portuguese Cuts

Portugal 10-year yield increased five basis points to 11.64 percent. The nation is planning to deepen budget cuts next year as it faces a moment of “national emergency,” and has to do more to meet its budget goals, Prime Minister Pedro Passos Coelho said.

Italian 10-year yields fell three basis points to 5.79 percent after Prime Minister Silvio Berlusconi won a parliamentary confidence vote. The rates earlier reached a 10-week high of 5.87 percent.

The German 10-year breakeven rate, a measure of inflation expectations based on the difference between yields on index-linked bonds and conventional securities, rose for an eighth day. The rate increased seven basis points to 173 basis points, the most since Aug. 25.

The euro-area inflation rate jumped to 3 percent last month from 2.5 percent in August, the European Union’s statistics office in Luxembourg said today. That’s the fastest in almost three years.

Bunds extended their drop after a U.S. report showed retail sales rose more in September than economists forecast. The yield on the benchmark European government security has risen 20 basis points this week.

French bonds have returned 4.1 percent this year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German debt has risen 6.5 percent and Spanish debt has gained 4.6 percent.

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