By Richard Hubbard
LONDON (Reuters) - European shares edged lower from 10-week highs and the dollar softened on Thursday as worries about the next step in U.S. monetary policy offset a brighter economic picture in Europe.
Markets have largely positioned for the Federal Reserve to begin paring back its $85 billion monthly stimulus in September but conflicting signals from policy makers and mixed economic data have undermined this view.
Late on Wednesday, the president of the St. Louis Fed, James Bullard, said he had not yet made up his mind on whether next month's policy meeting would be too soon to curb the asset purchases, known as quantitative easing or QE. [ID:nL2N0GF1A4]
"Markets were absolutely convinced we would see about a 20 percent reduction in the run rate of QE in the September meeting," said Mike Ingram, market commentator at BGC.
In response to the Bullard comments, the dollar at one point tumbled about 0.5 percent against the Japanese currency to a low of 97.63 yen. The fall was exacerbated by Japanese government efforts to stamp out talk of corporate tax cuts which might have helped boost the world's No. 3 economy.
Against a basket of major currencies, the dollar <.DXY> was down 0.3 percent, although it is off its lows of last week.
An early end to the Fed's bond buying is expected to boost U.S. Treasury yields, which should support the dollar, but would hurt shares and commodities boosted by central bank liquidity.
GROWTH SUPPORTS
Signs of recovery in Europe and growth in Britain supported the region's equity markets although investors have become wary over the implications for central bank policy.
German government bond yields hovered around 2013 highs on Thursday, after money market rates moved higher following data that showed the euro zone economy had emerged from an 18-month-long recession in the second quarter.
Ten-year German yields were holding at 1.81 percent, heading back towards levels not seen since April 2012.
The prospect of further improvement in the UK economy saw sterling rise to trade near a two-month high against the U.S. dollar and hold near recent peaks versus the euro.
Retail sales data for July due at 0830 GMT is forecast to pick up pace and rise 0.6 percent from a month earlier.
That will follow a string of recent releases - from rising house prices to a jump in services activity and brighter prospects for the job market - that have cemented expectations Britain is on the path to a sustained economic recovery.
In commodity markets, supplies worries related to unrest in Egypt and the brighter global growth outlook pushed oil prices higher and keep copper near a nine-week high.
A state of emergency was declared by the Egyptian government on Wednesday following deadly clashes between riot police and supporters of ousted President Mohamed Mursi. Investors fear the political turmoil could choke off routes such as the Suez Canal or spill over into big oil-producing nations.
"Egypt may not be a major oil producer but the Suez Canal is an important gateway, not just for oil flows but also for commodities. If there is any disruption or if the violence results in the shutting down of the canal, the impact will be quite severe," said Carl Larry, president of Houston-based consultancy Oil Outlook and Opinions.
Copper was little changed $7,323 a tonne, while gold stood near a 3-week high 1,337.69 an ounce.
(Editing by Catherine Evans)
