German 10-year government bonds advanced as concern that unrest in the Middle East will spread spurred demand for safer assets. Bunds also advanced as Chancellor Angela Merkel’s Christian Democratic Union lost an election in the city-state of Hamburg to the Social Democrats. Libyan leader Muammar Qaddafi’s son Saif warned of a civil war following attacks on anti-government protesters by security forces. Bunds gained, even as reports showed growth in Europe’s services and manufacturing industries accelerated to the fastest pace in more than four years in February and German business confidence climbed to a record. The Stoxx Europe 600 Index of shares fell 0.5 percent. “It’s safe haven flows due to tensions in North Africa and the Arab countries,” said Thomas Meissner, head of fixed-income research at DZ Bank AG in Frankfurt. “The PMIs came in stronger than expected so this week will be a bit tougher for bunds.” The yield on the 10-year bund, the euro region’s benchmark government security, fell five basis points to 3.20 percent as of 10:35 a.m. in London. It fell to 3.17 percent at the end of last week, the lowest since Jan. 31, according to data compiled by Bloomberg. The 2.5 percent security due January 2021 rose 0.41, or 4.1 euros per 1,000-euro ($1,367) face amount, to 94.125. The two-year note yield was little changed at 1.40 percent. Saif al-Islam Qaddafi called on protesters to engage in dialogue or face a civil war that risks “hundreds of thousands of dead,” as widening unrest posed the most serious challenge to his father’s 41 years of rule. ‘Harder Line’ The Hamburg election result may weaken Merkel’s position as she negotiates a comprehensive plan to contain the euro-region’s sovereign debt crisis. “Merkel will have to adopt a harder line to try to win round voters,” said Peter Chatwell, a fixed-income strategist at Credit Agricole Corporate & Investment Bank in London. “This may be positive for bunds.” German government bonds briefly pared their advance as a report showed business confidence in Europe’s largest economy rose to a record in February. The Munich-based Ifo institute said its business climate index, based on a survey of 7,000 executives, increased to 111.2 from 110.3 in January. That’s the highest since records for a reunified Germany began in 1991. Economists predicted the index would hold steady, according to the median of 38 forecasts in Bloomberg News survey. Higher Inflation A composite index of manufacturing and services industries based on a survey of euro-area purchasing managers in the 17- nation euro region in both industries rose to 58.4 from 57 in January, London-based Markit Economics said in an initial estimate today. That was the highest since July 2006 and above the 56.9 forecast by economists in a Bloomberg News survey. A figure above 50 indicates expansion. European Central Bank council member Athanasios Orphanides said inflation may stay above 2 percent longer than the bank expected and policy makers must be ready to take the appropriate action. “The sharp increases in food and energy prices over the last few months have been a surprise, and I don’t think we can rule out further surprises that would result in inflation staying above 2 percent for somewhat longer than what we expected before,” Orphanides said in an interview with Dow Jones Newswires. Portugal’s 10-year bond yield dropped three basis points to 7.47 percent, while the equivalent-maturity Italian yield decreased one basis point to 4.79 percent. The Spanish yield was little changed at 5.37 percent. Spain ‘Better’ The difference in yield, or spread, that investors demand to hold 10-year Spanish securities instead of similar maturity bunds has widened 28 basis points since Feb. 4, the last trading day before a European summit that failed to resolve differences over a bailout fund created to help member states service their deficits. The spread was at 217 basis points today. Portugal’s 10-year bond yielded 426 basis points more than the bund, up from 379 basis points on Feb. 4. Andrew Bosomworth, a Munich-based money manager at Pacific Investment Management Co., said Spain’s attractiveness as an investment “is certainly getting better.” “For the countries like Spain, where real economic progress and healing is starting to take place, it puts a different spin on markets like that,” Bosomworth said in an interview on Bloomberg Television’s “On the Move” with Francine Lacqua. “For the core countries that are going to be writing that big check, the implication is you don’t necessarily want to be located in there because they may be transferring more of their resources to support the periphery. At the very other extreme of the periphery, you still have that restructuring risk; I don’t think you want to be there.” German government bonds handed investors a loss of 1.8 percent this year, while Portuguese securities lost 3.2 percent, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Greek debt returned 3.2 percent, Spanish bonds gained 1.5 percent, while Irish securities lost 0.2 percent, the indexes show. To contact the reporters on this story: Keith Jenkins in London at Kjenkins3@bloomberg.net; Emma Charlton in London at echarlton1@bloomberg.net To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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