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~~~~~((#))016002000g-Government & Corporate Bonds

Euro bond yields drop as stocks plunge, Iraq and data in focus

LONDON: Euro zone government bond yields dropped to two week-lows on Monday with investors clinging to safe-haven debt as equities plunged due to worries that a prolonged US-led war in Iraq could damage an already fragile global economy.

US forces ramped up the pressure on President Saddam Hussein on Monday, blasting Baghdad with powerful air strikes and probing closer to the capital.

The Dow Jones Industrials index tumbled over 200 points or nearly 2.5 percent in the first thirty minutes of trade, sending already weaker European shares toward session lows and bonds soaring. Share investors were spooked by a weaker-than-expected Chicago Purchasing Mangers Index (PMI).

Manufacturing activity in the US Mid-West slunk back towards recession in March, with the Chicago PMI falling to 48.4 versus 54.9 in February, raising more doubts about the prospects for recovery given the current economic weakness and the 12-day old war in Iraq.

A reading of 50 or more in the Chicago PMI denotes growth in the manufacturing sector and in March, industry showed its first contraction in five months.

Analysts said the weak PMI figure could be the start of a poor week for US data and made a near-term US Federal Reserve rate cut more likely.

"It's a rotten number and sets the stage for the Fed cutting sooner rather than later," said David Brown, chief European economist at Bear Stearns.

"The markets are fighting on two fronts now. It is not just the war but also the weak economy. This is a bad figure for stocks and its a great figure as far as government debt markets are concerned."

Investors have been scooping up safe-haven bonds and dumping equities for six-straight sessions due to worries that a protracted war could severely damage already sluggish growth in the US, the world's biggest economy.

Brown believes that a weak set of US unemployment figures, particularly the key non-farm payroll total for March, due on Friday, could trigger a quick Fed rate cut.

"The key guiding light is going to come from the payrolls. If those numbers come through weak, the Fed could do a move before the weekend," he said.

At 1650 GMT, the benchmark 10-year Bund yield was at 4.043 percent, a fall of nine basis points (bps). percent.

ECONOMIC FOCUS

Less than two weeks ago at the start of the conflict many market participants had hoped for quick war which would have only a minimal impact on global economic growth.

But in the face of stiff resistance from Iraqi troops, politicians and military officials from both the US and Britain have warned of tough times ahead.

US Defence Secretary Donald Rumsfeld over the weekend rejected criticism that he had launched the war with insufficient ground strength, but predicted that Iraqi resistance would stiffen even more as coalition troops approached the capital.

Last week IMF head Horst Koehler said a global recession could no longer be ruled out should a long-lasting war in Iraq push up oil prices and dampen consumer confidence.

In its Global Financial Stability Report, published last Thursday, the IMF said a lengthy war in Iraq and spreading terrorism could undermine the fragile global economic recovery and further depress financial markets.

The International Monetary Fund (IMF) still expects the world economy to grow this year. But it is set to cut its 2003 growth forecast by more than signalled only a few weeks ago, a Greek finance ministry source said last Friday.

The source told Reuters that the IMF will cut its global growth forecast to around 3.0 percent from an original estimate of 3.7 percent. The IMF is due to publish its fresh World Economic Outlook on April 9.

DATA WATCH

As the war in Iraq entered its twelfth day and the market geared up for a stream of key economic data releases for the month of March this week, analysts said bonds would start to focus more closely on the latest batch of figures for some insight into the state of the global economy.

Severe weather in February caused some US indicators such as manufacturing or payrolls to decline sharply, while in the euro zone, rising unemployment and poor manufacturing and consumer sentiment figures have helped underpin fixed income markets.

"More generally people have become more alarmed by the state of the job markets, certainly in the United States, but also in Germany and France, which are by no means good," said Goldman Sachs' Garzarelli.

In the euro zone, markets will be keenly awaiting the outcome of the European Central Bank's monthly meeting in Rome on Thursday.

The ECB meets to discuss interest rates while key economic data on manufacturing and jobs are scheduled from the United States, but geopolitics were expected to be the main focus of attention.

"We have got pretty heavy data coming out this week, but the evidence is that the events in Iraq are continuing to dominate sentiment in the market," said Richard Adcock, senior technical analyst at UBS Warburg in London.

But trade could be thin on the ground as many market players were expected to hold their fire ahead of the ECB meeting.

The ECB is widely expected to keep rates on hold at 2.50 percent but investors will be waiting for some insight into the outlook for the euro zone economy from the bank.

The June Euribor futures contract, a barometer of euro zone rate expectations, was last at 97.695, up five basis points, indicating short-term interest rates at 2.32 percent.

Even if there is no cut from the ECB on Thursday, money markets are still pricing nearly an 80-percent chance that the ECB will shave another 25 basis points off its benchmark rates by June.

The interest-rate sensitive two-year Schatz was last yielding 2.40 percent, down nine basis points since Friday.

Weak stock markets once again pushed bond prices higher. June Bund futures rose to two-week highs, trading up 80 ticks at 114.75.

"It's all about the war and equities. The market isn't going to turn around until there is a clear sign of and end to the war," one Frankfurt-based debt trader said.

June Bunds were last at 114.74, up three-quarter of a point since Friday.-Reuters