Stocks rise ahead of U.S. inflation test

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By Danilo Masoni and Tom Westbrook

MILAN (Reuters) - Stocks made modest gains on Thursday on cautious optimism that U.S. data will confirm inflation is softening, while the yen rose on expectations the Bank of Japan will review the side effects of its ultra-easy policy.

A MSCI gauge of world stocks .MIWD00000PUS rose 0.4% to a four-week high by 1111 GMT ahead of data expected to show U.S. headline consumer inflation slow 6.5% in December from 7.1% the previous month, with core inflation, USCPFY=ECI seen at annual 5.7%, down from 6% a month earlier. Month-on-month headline inflation is seen at zero USCPI=ECI.

Bonds also rose, mirroring hopes of a softer inflation report, and the U.S. dollar was near seven-month lows against a basket of currencies. Europe's STOXX 600 .STOXX equity benchmark index rose 0.6% to its highest since April 2022.

The U.S. data due at 1330 GMT is set to have a big impact on markets by shaping expectations of the speed of interest rate hikes in the world's biggest economy. Markets have priced better-than-even odds that the Federal Reserve raises rates by 25 basis points, rather than 50, at February's meeting.

"Both the worst and best days for the S&P 500 in 2022 came on days of a CPI release. As such, it's inevitable that today’s U.S. CPI has the ability to shape the next month," wrote Deutsche Bank (ETR:DBKGn) strategist Jim Reid.

"The latest releases have seen two downside surprises on CPI in a row for the first time since the pandemic, which has led to growing hopes that the Fed might achieve a soft landing after all," he added.

Roberto Lottici, portfolio manager at Banca Ifigest, said he was concerned markets could potentially even react negatively to any big downside surprise in the U.S. CPI data.

"An inline figure would not give further impetus to the rally. A slightly lower number could extend the rise for a few sessions. But if it's too low I fear it could be interpreted negatively as a sign of a economic slowdown," he said.

The MSCI's broadest index of Asia-Pacific shares outside Japan .MIAPJ0000PUS rose 0.3% after climbing to a seven-month high, while Japan's Nikkei .N225 was steady.

S&P 500 futures ESc1 were broadly steady following gains for Wall Street indexes on Wednesday. Boston Federal Reserve bank president Susan Collins told the New York Times that she was leaning towards a 25 basis point hike.

Optimism for a more benign rates outlook and a pickup in demand as China emerges from strict COVID restrictions drove oil prices to new one-week peaks. O/R

Brent crude futures LCOc1 topped $83 on Thursday and were last up 1.2% at 83.62 a barrel.

U.S. Treasuries added to Wednesday's gains, pushing benchmark 10-year yields US10YT=RR down 3.2 basis points (bps) to 3.524%. German 10-year yields DE10YT=RR, the benchmark for the euro zone, fell 5 bps to 2.135%. Yields move in reverse to bond prices.

CHINA HOPES

Along with expectations that Western central banks will be gentler, investors are also banking on a recovery in China to help global growth, and are eyeing a potential policy shift in Japan.

The Bank of Japan stunned markets last month by widening the band around its 10-year bond yield target, a move that triggered a sudden rise in yields and a jump in the yen.

On Thursday. Japan's Yomiuri newspaper reported the BOJ will review the side-effects of Japan's ultra-easy settings sooner than expected - at next week's policy meetings - and that it may take additional steps to correct distortions in the yield curve.

The yen JPY=EBS rallied as much as 1.2%, accelerating gains after breaking key levels, and was last at 130.99 per dollar. Ten-year Japanese government bond futures 2JGBv1 fell to their lowest since May 2014.

Foreign exchange markets elsewhere were quieter ahead of the U.S. CPI data while China's reopening kept a bid under Asia's currencies. The dollar index =USD eased 0.1% to 103.06, not far from a seven-month low of 102.93 hit this week. The yuan CNY=CFXS traded at five-month highs at 6.7499 per dollar.

China on Thursday reported consumer price falls in December and a larger-than-expected drop in factory gate prices - underscoring weakness in demand - which investors are betting will recover over the coming months.

"It's not enough for China to come out of COVID to really turn the whole world economy around," said Steven Wieting, chief investment strategist and chief economist at Citi Global Wealth Investments. "But it really weighs in the opposite direction."

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