Stocks Dip, Bond Yields Rise On Rate Views

The prospect of tighter global monetary policy weighed on stocks on Tuesday.

The prospect of tighter global monetary policy weighed on stocks on Tuesday, with the euro holding firm ahead of a European Central Bank meeting expected to raise interest rates and signal more hikes to come.

Euro zone government bond yields hovered near recent multi-year highs ahead of the ECB announcement at 1145 GMT, while oil extended gains towards $71 a barrel after a cyclone disrupted oil and gas exports from Gulf state Oman.

The rise in government bond yields, in Europe to levels not seen since at least the start of a bull run in mid-2003, highlighted the narrowing valuation gap between stocks and bonds.

On Tuesday, solid U.S. services data and comments from Federal Reserve Chairman Ben Bernanke about lingering inflation further dented fading expectations of rate cuts in the United States this year and pushed 2-year yields above the key 5 percent level for the first time since January.

"Many people were surprised by the (remarks) that a rate cut this year will not be as possible," said Heinz-Gerd Sonnenschein, an equities analyst at Postbank in Stuttgart.

"Thinking about the strong (euro zone) economy driven by Germany and maybe with the U.S. picking up quicker than people expected ... one gets a bit more hawkish and a bit more fear about rising rates," he said.

Europe's FTSEurofirst 300 fell for a third day running, down 0.6 percent to its lowest in almost a week at 1,602.5 points. It is only the fourth time this year the index has fallen for more than two days in a row.

Miners Anglo-American and Rio Tinto slid as a dip in copper prices prompted some profit taking after recent gains, while mobile giant Vodafone was 3 percent lower after going ex-dividend.

ASIA MIXED, CHINA CALMER

Markets in Asia were mixed, with investors concerned about the impact of U.S. interest rates remaining higher for longer and also watching the see-sawing Chinese index.

The Shanghai Composite Index closed up 0.9 percent but not before falling 2.3 percent in early trade, having plunged as much as 21 percent over the past week or so.

"I think the market is calming down now. After the sharp decline and the dramatic rebound, the environment is regaining stability," said Xiang Weida, analyst at Great Wall Securities.

Hong Kong's Hang Seng rose 0.3 percent, while Tokyo's Nikkei ended down 0.1 percent, dragged lower by exporters such as Canon Inc. on concern over potentially slower U.S. demand.

MSCI's All Country World index was down 0.1 percent but still up almost 10 percent this year.

The threat of higher interest rates kept the euro firm against the dollar and the yen as traders hoped for a steer on the interest rate outlook from ECB President Jean-Claude Trichet at his post-announcement news conference.

"Our general perception is that the ECB will continue tightening policy and even deliver up to 4.75 percent during the next year, but markets are already pricing in almost two additional hikes so it will be quite difficult for Trichet to top these expectations," Tobias Thygesen, senior analyst at Danske Markets said.

"We expect him to be relatively hawkish and signal that monetary tightening isn't at the end yet, but that doesn't mean that we will see the euro strengthening," he said.

The euro was steady at $1.3525 and down slightly versus the yen at 16.85, having hit an all-time high of 164.61 on Tuesday.

The high yielding Australian dollar rose to a 17-year high against the U.S. dollar after strong first-quarter growth data suggested Australian rates could rise further, helping lift the New Zealand dollar to its highest since being floated in 1985.