European share prices edged up while the single currency was steady on Wednesday as markets waited to see if the European Central Bank and the U.S. Federal Reserve will respond to fresh evidence of slowing global economic growth.
Investors are focused on the ECB's Thursday meeting to see how the central bank's President Mario Draghi plans to make good on his promise to protect the euro. Few believe the Fed will announce fresh monetary stimulus at the end of its two-day meeting later on Wednesday.
Those who expect Draghi to live up to his promise in the face of repeated opposition from Germany's central bank are expected to sell the euro and European shares and drive up Spanish and Italian bond yields if the ECB does nothing.
"The market is relying on Mario Draghi's comments that the ECB will do whatever it takes to preserve the euro, especially on his 'believe me, it will be enough' assertion," said Mouhammed Choukeir, chief investment officer at Kleinwort Benson.
"On Thursday the European Central Bank may announce it will resume purchasing peripheral euro zone government bonds through its Securities Markets Programme (SMP). The question is how much is it prepared to spend?" he said.
However, any move still hangs in the balance as the German Bundesbank has staunchly resisted a bigger role for ECB that would let it buy more sovereign debt, which it believes flouts European law banning monetary financing of governments.
Nick Parsons, head of markets strategy in Europe for National Australia Bank in London, said the euro could fall a couple of U.S. cents from current levels if Draghi fails to act.
Parsons said the single currency might fall back below $1.2130 against the dollar, though a firm response by the ECB could lift it above last week's peak of $1.2390.
"After that you'd really be looking at $1.2693, the high on the last trading day of June, but we'd really need to see monetary shock and awe to take us to those sorts of levels," he said.
The euro was flat on Wednesday at $1.2315, coming under some pressure after Bundesbank President Jens Weidmann said in an internal interview that governments overestimated the ECB's capacities and placed too many demands on it.
BUMPY RIDE AHEAD
Equity markets looked set for a similar rollercoaster ride on Thursday.
"Given the fact that we have now seen eight weeks in a row of positive returns on European equities <.FTEU3>, there is certainly a risk that we might see a retreat in the area of 5 percent in the near term," said Gerhard Schwarz, head of equity strategy at Baader Bank.
If the ECB does not act, "then the question is how quickly we will get to a more meaningful crisis response, and I think that certainly the macro news flow is still disappointing, so this will come back to the centre stage again," he said.
Since Draghi first made his comments of fresh support for the euro last Thursday, equity markets have enjoyed broad gains. The STOXX 600 index of European companies has risen about 4.5 percent, although it gave up some of these gains on Tuesday on scepticism about whether the ECB would deliver.
The FTSEurofirst 300 index of top European shares was slightly higher, up 0.25 percent at 1,065.80 points, having posted a 4.1 percent rise in July, the second-best monthly rise this year after strong gains in June.
U.S. stock index futures rose on Wednesday after two straight sessions of declines ahead of the Fed's announcement.
In the debt markets, where yields on Spanish and Italian debt have plunged from near unsustainable levels since Draghi's comments, sentiment was improving strongly on Wednesday.
Italian 10-year government bond yields were down 16 basis points at 5.92 percent and equivalent Spanish yields were 7.5 bps lower at 6.7 percent. The appetite for riskier debt pushed 10-year German government bond yields 5 basis points higher to 1.34 percent.
Some fixed income analysts are looking for the ECB to either make clear what yield level on Spanish and Italian bonds they consider too high, or say they will come into the markets directly and buy debt to lower the yields.
"But if you get neither of those, I think there will be disappointment, and you could well see yields go up towards the highs of last week," Elisabeth Afseth, fixed income analyst at Investec said.
ECONOMIC GLOOM
The better tone in the markets on Wednesday came despite data showing Europe and Asia's economic performance worsening.
Germany's manufacturing sector contracted in July at its fastest pace in more than three years, according to the latest Markit Purchasing Managers' Index (PMI).
The PMI data also showed output flagged more than expected in Britain's manufacturing sector during July, dealing a severe blow to hopes that the country will emerge from recession soon.
"It is consistent with a very sharp slowing in the global economy," said Jens Larsen, chief European economist for RBC Capital Markets.
The broader euro zone manufacturing sector contracted for the 11th straight month in July, the data showed.
Earlier, China's official factory purchasing managers' index fell to an eight-month low of 50.1 in July, suggesting virtually no growth in the world's second-biggest economy.
The Chinese data contributed to a sharp fall in the greenback versus the Japanese yen, touching a two-month low of 77.90 yen, and came after signs of decelerating growth from other major Asian exporters including Japan, South Korea and Taiwan.
The Chinese data sent Brent crude oil to its lowest in almost a week before prices steadied just above $105 a barrel.
"The market is preparing for the Fed and ECB statements, and they are expecting disappointment because the Fed is unlikely to unveil a third quantitative easing ... And whatever comes from the ECB will not be enough to end the euro zone debt crisis," said Eugen Weinberg, analyst at Commerzbank in Frankfurt.
