The euro rose against the dollar and shares gained on Tuesday as Europe's worsening debt crisis and its impact on global growth encouraged talk of a policy response by the world's major central banks.
The US Federal Reserve begins a two-day policy setting meeting later in the day, with attention focused on whether it will unveil any more stimulus to support a flagging recovery.
While a surprise fall in British inflation for May also strengthened the chance of steps from the Bank of England to support the UK economy as it feels the heat of the euro zone's problems.
“Everything is pointing towards another liquidity injection into the system,” said Francois Savary, chief investment officer at Swiss bank Reyl.
However, gains in riskier asset markets were limited by concerns over a sharp rise in Spain's short-term borrowing costs, a big fall in German investor confidence, and fresh worries about Greece's commitment to its bailout plan.
The single currency gained 0.3 percent to trade around $1.2610, still below a one-month high of $1.2748 hit on Monday.
The pan-European FTSEurofirst 300 share index rose 0.45 percent, but Brent crude hit a fresh 16-month low at $94.44 a barrel on slack demand due to fears about the slowing euro zone economy.
SPANISH YIELDS JUMP
Spain was made to pay yields of over five percent to sell Treasury bills in an auction as investors worried the country will soon have to ask for international aid. It faces a bigger test on Thursday with a sale of longer-term bonds.
“The yields are over 5 percent in both lines, which is back at the levels we saw in November 2011 when the market was in huge distress and the ECB was forced to intervene,” Peter Chatwell, an interest-rate strategist at Credit Agricole.
Borrowing costs across the euro zone fell sharply after the European Central Bank flooded the market with around 1 trillion euros in cheap credit through two long-term refinancing operations (LTROs) in December and February but they have since leapt back up.
Spain has said the ECB should take more steps to ease the crisis, but the bank's head, Mario Draghi, said this month that it was up to Europe's politicians to fix the euro zone.
However, he has hinted the bank may soon cut interest rates, pointing to heavy downside risks for the European economy and saying there was no inflation risk in any euro area country.
Spain's debt problems and uncertainty over the Greek election outcome took its toll on investor sentiment in Europe's biggest economy, according to the Mannheim-based ZEW economic think tank's monthly poll.
The ZEW index fell in June at its fastest rate since October 1998, to -16.9 from 10.8 in May, way below the forecast in a Reuters poll of 42 analysts for a drop to 4.0.
“In the second quarter, Germany's economy is likely to slow down markedly, in particular private investment,” said Christian Schulz, Senior Economist, Berenberg Bank.
“With the euro crisis once again threatening to push the German economy into recession this summer, a convincing policy response becomes pivotal for Germany as well,” he said.
The concerns about Greece have also not gone away despite signs that Greece's pro-bailout conservatives looked set to form a coalition government with the Socialists.
Conservative New Democracy leader Antonis Samaras has promised to negotiate less punishing terms for Greece's international bailout, after only narrowly beating a radical left-wing party that campaigned to scrap the austerity deal.
Any move by Greece's to change details of its 130-billion-euro bailout is expected to be opposed by Germany.
OPERATION TWIST
US stock index futures pointed to a mixed open on Wall Street as investors await the outcome of the Fed meeting.
The consensus had been for the Fed to announce no further quantitative easing - effectively creating money to purchase assets - for now, but the recent disappointing economic data is may prompt the Fed to consider extending its long-term bond-buying programme, known as Operation Twist, by a few months from the current June deadline.
“Across the Street economists largely anticipate some form of sterilized asset purchases and an extension of Operation Twist,” said Morgan Stanley executive director Gabriel de Kock.
The liquidity boost delivered by previous doses of monetary stimulus from the Fed has lifted global equities and most commodities, and markets have become highly sensitive to the waxing or waning of expectations of more such measures. - Reuters