German data lifts European shares as Fed decision looms

By Marc Jones

LONDON (Reuters) - Financial markets were cautious on Wednesday as investors waited to see if the Federal Reserve might announce it is trimmming its massive stimulus programme.

European shares tiptoed higher, helped by a strong German business sentiment survey, but it was little more than fine tuning ahead of the Fed's statement. Moves in the dollar and benchmark U.S. and European government bonds were also tight.

The debate over when the Fed will begin to halt the flow of cheap dollars has dominated trading worldwide for months amid worries it could trigger a turbulent reaction from investors who have become all too used to the support.

A majority of economists polled by Reuters expect the Fed to wait until March before it starts the process, but recent encouraging data from the U.S. and other parts of the world have raised the odds of a move in January, if not now.

"Probably the strongest encouragement for tapering to begin this evening is the stability in financial markets," said Derek Halpenny, European head of global markets research at Bank of Tokyo-Mitsubishi UFJ.

"Our hunch is that a taper announcement may well encourage a year-end rally in global equity markets as an element of policy uncertainty is cleared," he said, adding the dollar should also do well against the yen.

Another Japanese trade deficit and expectations that Prime Minister Shinzo Abe could hint at fresh stimulus in a speech later was already tugging at the yen.

There was also no shortage of European distractions to fill the wait for the Fed.

Euro zone watchers had details thrashed out overnight on the bloc's new bank rescue mechanism to pick through, while German Ifo data showed business morale in Europe's biggest economy hit its highest level this month since April 2012, a sign that economic growth could accelerate next year.

Bank of England meeting minutes due at 0930 GMT were also on tap.

The pan-regional FTSEurofirst 300 extended gains to 0.8 percent after the German data. London's FTSE <.FTSE>, Paris's CAC 40 <.FCHI> and Frankfurt's Dax <.GDAXI> all made ground although the moves only reversed Tuesday's falls. <.EU>

The euro was steady at $1.3767, having risen 0.2 percent in the previous two sessions. The common currency touched a six-week high of $1.3811 on December 11.

FED FOCUS

The Fed's stimulus campaign has been a major driver for global risk assets in recent years.

The Federal Open Market Committee, the central bank's policy setting group, will release a policy statement at 1900 GMT, (1400 EST) followed by a press conference with Fed Chairman Ben Bernanke a half hour later.

As the decision loomed, Indonesia's rupiah fell to a five-year low of 12,175 per dollar, while the Philippine peso dropped 0.3 percent to 44.13 to the dollar and the Thai baht eased 0.5 percent to 32.25, a one-week low.

One of the results of the Fed's cheap money has been that higher-yielding emerging market assets have been snapped up, a trade likely to reverse to some degree as the central bank's course changes.

"We are bearish on those currencies held back by weak or deteriorating current account positions, inflation challenges and, in some cases, poor internal debt dynamics," Morgan Stanley analysts wrote in a report.

The other standout move in Asia was in Tokyo where the Nikkei <.N225> climbed 2 percent as hedge funds bet that whatever the Fed outcome was, it would have little impact on Japan's ultra-loose policy path.

S&P 500 E-mini futures pointed to Wall Street opening up around 0.3 percent later having dipped on Tuesday. <.N> And with the Nikkei rallying, the dollar bounced 0.3 percent to 103.00 yen but was short of Friday's five-year high of 103.925 yen.

"We may see nothing at all from the Fed, although they would give a strong indication a taper is on the cards. This is a strong possibility as well, which could be USD negative," Chris Weston at financial spreadbetter IG wrote in a note.

Among commodities, U.S. crude prices were steady at $97.25 a barrel, recovering from the previous session's 0.3 percent decline as Brent dipped to $108.37.

Gold rose 0.3 percent to around $1,234 an ounce, having fallen 0.8 percent overnight. The precious metal has fallen more than 26 percent in 2013, heading for its worst year since 1981.

(Additional reporting by Dominic Lau in Tokyo; Editing by Susan Fenton)