Dollar slides as QE3 looms, world stocks subdued

The dollar tumbled to its lowest level since early May and stock and bond markets curbed some of their resurgent appetite for risk on Thursday as investors waited to see whether the U.S. Federal Reserve announces a new round of money printing.

As the dollar suffered from expectations for QE - which would be equal to printing money and diluting the value of the currency - the euro stayed near four-month highs against the U.S. currency, helped by the signs the euro zone may be starting to get on top of its debt troubles.

"Any good will towards risk assets, probably more so in FX land, could be undone pretty quickly if Ben Bernanke fails to live up to what is expected of him and the Fed board today," said Chris Weston, trader at IG Markets.

A Reuters poll showed economists raised their bets of a third round of Fed bond buying known as quantitative easing (QE) to 65 percent from 60 percent in August.

Fed expectations and the potential for a rise in tensions in the Middle East following the killing of the U.S. ambassador in Libya kept oil prices near $116, consolidating a 30 percent rise since late June. Gold prices hovered at 6-month highs.

The MSCI index of global shares was down 0.3 percent ahead of the U.S. open, retreating from a five-month high reached on Wednesday after a German court gave the green light to the euro zone's new bailout fund.

Shares in London, Paris and Frankfurt were all in the red and the S&P 500, which has risen 9 percent since June - well below the 20 percent surge in European bluechips - was seen opening slightly lower with investors twitchy about the Fed.

Markets were also braced for a deluge of U.S data, from employment to producer prices.

The Fed decision is expected to be released at 1630 GMT, followed by Chairman Ben Bernanke's news conference about two hours later.

German Bunds rose as selling on Wednesday was considered overdone, but gains could be wiped out if the Fed disappoints.

"It will be a massive disappointment if they don't do anything. We're looking for QE3 and some extension of the zero interest rate policy. If we don't get that it's probably going to be another excuse for Bunds to sell off," a London-based bond market trader who requested anonymity, said.

ECB warning

The Fed's announcement on a potential new round of mortgage-based purchases is seen by many economists as a welcome move but one that is unlikely to have a sustained long-term benefit for the economic environment.

Europe's ability to overcome its debt troubles remains the central focus. Hopes that the European Central Bank's bond-buying plans could stabilise matters saw South Korea's central bank unexpectedly leave interest rates steady on Thursday while New Zealand, Indonesia and the Philippines also stood pat at policy meetings.

Switzerland's central bank pledged to keep the safe-haven Swiss franc pegged firmly below 1.20 per to the euro, saying it too was waiting to see how things developed in the euro zone.

A new study published in the ECB's monthly report warned that Spain's debts could hit 104 percent of its economic output by 2016 if it only manages to achieve half of its fiscal repair targets, while in Italy debts could peak at 125 percent.

"This underlines the importance of governments living up to their commitments," the ECB said. "Failing to achieve this target will immediately give rise to substantial risks for debt sustainability."

The central bank's recently announced plans to buy troubled government debt in potentially unlimited quantities helped Italy secure its lowest three-year borrowing costs in almost two years and sell a 15-year bond for the first time in over 12 months.

"Relative to market levels everything has gone at least 5 basis points in yield terms than they were in the secondary market ... it's very good by Italian standards," said Marc Ostwald, a strategist at Monument Securities.

"It really does go to show how much optimism there is on the back of the OMT (ECB bond-buying plan)."

EU/IMF bailout poster-child Ireland also continued to feel its way back into the open market and saw its borrowing costs halve at another auction of three-month paper.