German bonds fall; world stocks, euro vulnerable

By Natsuko Waki

LONDON (Reuters) - German government bond yields hit their highest in nearly a month and world stocks held near 7-week lows on Thursday, a day after a weak debt sale in Berlin fanned fears the euro zone debt crisis is starting to threaten its biggest economy.

The euro remained vulnerable near a 7-week low against the dollar as investors eyed a meeting of leaders from France, Germany and Italy for any signs of cracks in Berlin's resistance to more concerted action to end the two-year-old crisis.

Repercussions from the auction, in which Germany found no buyers for almost half of the 6 billion euros on offer, extended into a second day, with Bund futures falling 115 ticks on the day to 134.66, the lowest since Oct. 31.

Ten-year German government bond yields rose as high as 2.14 percent, compared with just 1.724 percent earlier this month.

That is higher than the equivalent U.S. Treasury yield of around 1.88 percent and Japan's 1 percent , although the difference also reflects the higher benchmark interest rate set by the European Central Bank.

"I think we are moving closer to a policy response probably, which could be either more aggressive ECB action or the idea of euro bonds could gain some traction," said Rainer Guntermann, strategist at Commerzbank.

"In either case the credit of the core countries could be increasingly diluted, including also German Bunds especially when it comes to euro bonds."

German, U.S. and UK 10-year real yields -- benchmark government bond yields minus consumer prices inflation rate -- are in negative territory, with Japan boasting the highest real yield among the four of around 1 percent.

The MSCI world equity index was up 0.15 percent. The index has fallen 15 percent since January.

European stocks rose 0.6 percent on the day while emerging stocks also added 0.6 percent. Wall Street is closed for the Thanksgiving Day holiday.

U.S. crude oil rose half a percent to $96.60 a barrel.

The euro was up 0.3 percent at $1.3379, having fallen as low as $1.3318 on Wednesday.

"It is a case of two steps down and one step up for the euro," said Carl Hammer, currency strategist at Nordea in Stockholm.

"The Bund auction got people wondering about how big German debt is and it coincided with (European Commission President Jose Manuel) Barroso talking about euro bonds".

Funding stresses for European banks escalated, with the cost to swap euros into dollars in the currency swap market rising to fresh three-year highs of 148 basis points .

The premium investors demand to hold Portuguese government bonds rather than benchmark German Bunds rose after Fitch downgraded Portugal's rating to junk status.

Citing large fiscal imbalances, high debts and large fiscal imbalances, Fitch cut Portugal to BB+ from BBB-, still one notch higher than Moody's rating of Ba2. S&P still rates Portugal at investment grade.

The dollar fell a quarter percent against a basket of major currencies.

(Editing by Patrick Graham, John Stonestreet)