By Patrick Graham
LONDON (Reuters) - Stock markets recovered from an initial battering on Wednesday, some upbeat signals from Britain and Japan helping offset what for many investors is a worrying revival of expectations for rises in U.S. interest rates this year.
The dollar, hammered by a virtual abandoning of expectations for tighter rates this year, hit three-week highs after Atlanta Federal Reserve President Dennis Lockhart and other officials on Tuesday played up chances of hikes this year.
Any shift towards more tightening would be bad news for stock markets, which have been comforted by the idea there would be no squeeze on the funds and companies that have borrowed and invested trillions of dollars globally over the past decade.
Asian markets fell broadly on that view, with Hong Kong and China down around 1.5 percent. European markets were steady to slightly lower while Wall Street was set to open flat.
"A barrage of comments from regional Fed presidents has forced rate markets to begin pricing more chance of Fed tightening in the coming months," analysts from French bank BNP Paribas said in a morning note.
"The shift supports the dollar and this adjustment could conceivably have quite a bit further to go."
Data on Tuesday showed the biggest rise in U.S. consumer prices in more than three years in April as gasoline prices and rents rose, while other data showed housing starts and industrial production rebounded strongly.
Lockhart, viewed as a centrist on the Federal Reserve's board, said he still assumed there would be two to three rate hikes this year, a view echoed by San Francisco Fed President John Williams.
Interest rate futures moved to price in a 70 percent chance of a hike by December, with a 50 percent chance of a move priced in by September. Chances of one in June were still just 15 percent, up from less than 5 percent on Tuesday.
That puts minutes from the Fed's April meeting due at 1800 GMT front and centre for investors on Wednesday. [FED]
Deutsche Bank credit strategist Jim Reid suggested the U.S. central bank was for the moment just keeping its options open.
"There's still a clearly large gap between where the market is and the recent rhetoric from the Fed," he said. "Importantly we're yet to hear from either the Fed President (Janet) Yellen or Vice-Chair (Stanley) Fischer recently."
Fischer is due to speak publicly on Thursday, Yellen not until next week.
BREXIT, OR NOT
A UK poll provided some comfort to financial investors worried about the chances of Britain voting to leave the European Union next month - showing the "In" campaign 18 points in front. That drove sterling to its highest in three weeks.
Stoking inflation expectations is a recent recovery in oil prices, which hit seven-month highs on Tuesday, on expectations of a drawdown in U.S. crude stockpiles and a new wildfire threat on Canadian oil supplies.
After some morning losses U.S. crude futures were flat at $48.26, within sight of Tuesday's high of $48.76 per barrel.
Japanese shares and the yen were volatile, with markets digesting surprisingly strong annualised 1.7 percent growth in the January-March quarter that may be masking pockets of weakness.
The Nikkei 225 ended flat, as the yen gave up gains seen immediately following the GDP data to slip 0.1 percent to 109.26 per dollar.
"The yen strengthened a bit because growth was stronger than many had expected," said Ayako Sera, market strategist at Sumitomo Trust and Banking. "But looking at the details, there were still some concerning areas, including capital spending."
Markets are now looking to Prime Minister Shinzo Abe's meeting with his coalition party leader, where he could discuss postponing a planned sales tax hike to support the flagging economy.
If that adds up to less chance of additional monetary easing by the Bank of Japan it might support the yen, but gains for Tokyo stocks generally push the currency in the opposite direction.
(editing by John Stonestreet)
