(Updates throughout, changes dateline)
* Markets temper expectations for U.S. rate increases
* European shares down on bank jitters before M.Stanley
* Oil softens but offers no relief for inflation fears
By Amanda Cooper
LONDON, June 18 (Reuters) - The dollar was on the back foot
on Wednesday after a flurry of weak U.S. data cast doubt over
market expectations for a series of rate rises this year, while
nagging worries about the banking sector weighed on European
stocks ahead of results from Morgan Stanley <MS.N>.
A fourth consecutive decline in the oil price <CLc1>, which
has edged down after a plan by world number one exporter Saudi
Arabia to raise output, did little to dispel concern among
investors or central bankers about the threat of inflation.
Government bond yields steadied after recent declines as
comments from officials at the Federal Reserve, the European
Central Bank and the Bank of England have all tempered
expectations for a series of rate rises this year from all three
central banks.
Policymakers around the world have warned price pressures
from record-high fuel and food costs could warrant tighter
monetary policy, even at the expense of growth in the short
term.
"The key issue in ECB and Fed talk is whether the recent
tack taken by central bankers -- namely, that one-two hikes may
not result in a protracted tightening -- is upheld, contradicted
or simply skirted around. That topic is going to set the bond
market tone for the next 2-3 days, given the paucity of key data
for the rest of the week," said Luca Jellinek, a strategist at
ABN AMRO.
ECB Council member Yves Mersch said late on Tuesday there is
a 'possible certainty' of an ECB interest rate hike at the July
3 meeting, but downplayed the chances of a series of hikes,
while ECB Executive Board member Lorenzo Bini Smaghi was quoted
in an Italian daily as saying a quarter percentage point rate
hike should be enough to bring euro zone inflation below the
ECB's 2 percent target.
But fellow Executive Board member Juergen Starck said late
on Tuesday inflation was unacceptably high, pushing the euro to
11-month highs against the yen <EURJPY=> at 167.99 yen,
according to Reuters data.
The euro was a touch softer against the dollar, dipping 0.1
percent to $1.5480 by 0857 GMT, but still up 0.5 percent this
week and analysts believe it has plenty of scope for further
gains, given the ECB's suggestion of a rate rise next month.
" ... if the markets take out rate hikes in the U.S. at the
same time as the ECB persists in its desire to raise rates in
July, I wouldn't rule out a new high in euro/dollar," said Teis
Knuthsen, head of FX research at Danske Bank in Copenhagen.
BONDS STEADY, STOCKS OFF
Against this backdrop, two-year euro zone bond yields
<EU2YT=-RR> -- often the most sensitive to switches in investor
thinking on the likely path of interest rates -- were virtually
unchanged on the day at 4.634 percent, but still within striking
distance of their highest since late 2000.
Weak U.S. housing and industrial production data, along with
figures that showed housing starts fell to their lowest since
1991 reined in the dollar and Wall Street stocks, which took an
additional hit from a brokerage that warned U.S. banks may have
to raise as much as $65 billion in capital to shore up balance
sheets eroded by the mortgage crisis.
European stocks, as reflected by the FTSEurofirst 300 index
<> of leading European shares, fell nearly 1 percent in
morning trade, led by declines in financials as investor concern
about Morgan Stanley results later on weighed on the likes of
Royal Bank of Scotland <RBS.L>, UBS <UBSN.VX> and Banco
Santander <SAN.MC>.
The FTSEurofirst 300 was down 0.8 percent at 1,259.26, while
the MSCI world equities index <.MIWD00000PUS> was off 0.1
percent.
Oil prices dipped on Wednesday, taking U.S. crude futures
for July <CLc1> down 0.3 percent to $133.65 a barrel and bringing
the four-day loss to 2.2 percent. Crude oil hit a record of
nearly $140 on Monday.
OPEC top producer Saudi Arabia has promised to ramp up
production to its fastest rate in decades, UN chief Ban Ki-moon
was quoted as saying last weekend. []
Pointing to more inflationary pressures ahead, U.S. corn and
soybean prices closed near record highs on Tuesday as flooding
in the U.S. Midwest damaged U.S. crop prospects.
Still, in the face of a slowing economy, the Federal Reserve
is now seen almost certain to keep its benchmark rate at 2.0
percent at a two-day meeting next week.
"What the Fed actually does with rates from now on depends
more on unforecastable oil prices than the near-term direction
of the macro economy," Rob Carnell, a London-based economist at
ING said in a note.
"But whilst we would not rule out a hike, we still believe
that rates may yet trough lower before the end of this interest
rate cycle."
In Asia, stocks extended a fragile two-day rise, helped in
part by the softening in the oil price, while Japanese
government bond prices <2JGBv1> rallied, boosted by receding
expectations for aggressive interest rate rises.
In commodities, gold <XAU=> dipped to $882.80/883.75 an
ounce from $884.20/885.40 late in New York on Tuesday.
(Additional reporting by Ian Chua and Toni Vorobyova in London
and Anshuman Daga in Singapore; Editing by Malcolm Whittaker)
