Bruised Euro Holds Ground Ahead of Inflation Test

The euro clung to modest gains and a rally in Europe's share and bond markets cooled on Thursday as investors put bets on possible fresh ECB stimulus next week on hold ahead of German inflation data.

Escalating tensions in Ukraine kept riskier assets under pressure, with the top share index in Germany -- whose corporate sector has strong trade ties with Russia -- extending initial losses on reports Russian troops had crossed the border to fight alongside separatists.

The recently-battered euro inched off a one-year low versus the dollar to $1.3204 as bond markets steadied with yields in most key parts of the euro zone pinned near record lows.

Ahead of the German August inflation numbers, which will be released state-by-state throughout the day, equivalent Spanish figures saw a slightly smaller-than-forecast drop to 0.5 per cent year on year and revised Spanish second quarter GDP held up at growth of 0.6 per cent.

European Central Bank sources told Reuters on Wednesday it was unlikely to take new policy action next week unless overall euro zone inflation figures due on Friday show the bloc clearly sliding towards deflation.

"If the German CPI (inflation figures) underline strengthening deflation, it will fuel caution towards the euro zone... and add selling pressure on the euro," said Junichi Ishikawa, a market strategist at IG Securities."

European stocks took their lead from a quiet Asia as the main markets in London, Frankfurt and Paris opened 0.2, 0.4 and 0.2 per cent lower after three days of gains.

But by 0845 GMT, the DAX was down 0.7 per cent, as Kiev accused Moscow of launching a fresh military incursion across the countries' border.

The news dealt a blow to hopes sparked by this week's meeting between their leaders. Shares in Moscow tumbled 2.5 percent and the rouble dropped 0.4 per cent, while Ukraine's credit default swaps surged to three-month highs and its dollar bonds fell.

"Recent optimism around a negotiated solution to the crisis as reflected in market pricing appears overdone in our view," JP Morgan analysts wrote in a note to clients.

Inflation Expectations

Trading in Asia had been largely subdued with stocks pulling back from a 6-1/2 year high despite Wall Street grinding out another incremental record high overnight.

In the currency market, the Australian dollar was in demand after second quarter business investment data beat forecasts, while the US dollar all but sat on recent gains as it hovered 0.1 per cent lower.

US Treasuries had rallied overnight as month-end buying helped send 30-year yields to their lowest in over a year. Euro zone government bond yields continued to probe record lows in early European trading as markets waited on the German inflation figures.

"For the euro area, inflation may now be 0.3 or 0.4 per cent but I don't think this one figure is of major importance," said Piet Lammens, a strategist at KBC in Brussels.

"What is important is that (ECB head Mario) Draghi said (in a recent speech) that during August inflation expectations have dropped substantially."

US crude oil dipped after choppy trading overnight following a report showing declining US gasoline demand.

US crude dipped 33 cents to $93.55 a barrel with the market looking to US economic data due later in the session to gauge the outlook for demand from the world's largest oil consumer.

Gold edged up 0.3 per cent to $1,286.36 an ounce as the more subdued dollar and political tensions helped offset selling pressure from bullish US equities.

Copyright: Thomson Reuters 2014