Global Markets - Countdown to first Fed hike in a year under way, but focus shifting to 2017

By Dhara Ranasinghe

LONDON (Reuters) - World stocks and the U.S. dollar edged lower, while government bond yields fell, with investors certain the Federal Reserve will lift interest rates for the first time in a year on Wednesday but less so about what it may do in 2017.

European shares fell 0.4 percent and U.S. stock futures were flat, suggesting a cautious start to Wall Street trading after Tuesday's stock market rally to all-time highs.

Asian stocks outside Japan eked out just a 0.1 percent gain, while benchmark indexes in Japan and China dithered either side of flat with investors reluctant to push shares much higher before the Fed meeting.

The Fed is widely tipped to lift interest rates 25 basis points to 0.50-0.75 percent at the end of a two-day meeting on Wednesday. Its rate announcement is due at 1900 GMT, followed by Chair Janet Yellen's news conference 30 minutes later.

It would be the Fed's first interest rate hike in a year and its second since the financial crisis.

With a rise fully priced in by markets, eyes are on the Fed's economic and rate "dot plots" for a sense of how policymakers think President-elect Donald Trump's policies will impact growth and inflation.

"Last year the Fed guided the markets to expect at least four rate rises this year, guidance that proved to be woefully wide of the mark, and it is likely that they won't want to make the same mistake again," said Michael Hewson, chief market analyst at CMC Markets.

"That suggests that Fed chief Janet Yellen can expect some serious cross-examination of how the FOMC (Federal Open Market Committee) view not only the economy, but also President elect Donald Trump's plans for it."

For others, the challenge for Yellen is how to signal further rate increases without triggering strong gains in the dollar that could undermine growth.

The dollar index, which measures against a basket of six major currencies, hit 14-year peaks last month on expectations for higher inflation and interest rates.

The euro traded at $1.0646 on Wednesday, up 0.2 percent on the day and off a recent 20-month trough at $1.0505. The dollar was also a touch weaker against the yen at 114.92, while the dollar index was 0.2 percent lower at 100.88.

"Janet Yellen is in a corner for the December meeting," said Nicolas Forest, global head of fixed income at Candriam Investors Group. "She has to hike interest rates but the dollar is strong, so she has to decide between a dovish and a hawkish hike."

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Treasuries have already priced in a rate hike and more, with 10-year yields pulling back from peaks seen earlier this week just above 2.5 percent.

In contrast to the Fed, the European Central Bank only last week extended its asset-buying campaign and moved to purchase more short-term debt.

Germany's 2-year government bond yield, trading at minus 0.765 percent, is within sight of recent record lows, while U.S. equivalents are reaching ground last trod in April 2010 at around 1.18 percent.

As a result, the spread between U.S. and German two-year yields is at its widest since late 2005, with Treasuries offering a mouth-watering premium of 192 basis points.

The Bank of Japan, meanwhile, increased government bond purchases in regular market operations on Wednesday for the first time since adopting its yield curve control in September, signalling its readiness to intervene against unwelcome rises in long-term interest rates.

Oil ran into profit-taking following a reported rise in U.S. crude inventories and an estimate that OPEC may have produced more crude in November than previously thought.

U.S. crude futures, which hit a high of $53.41 on Tuesday, were down 71 cents at $52.27 a barrel. Brent crude eased 70 cents to $55.03.

(Additional reporting by Wayne Cole in SYDNEY; Editing by Robin Pomeroy)