Euro edges lower ahead of pre-ECB inflation data

LONDON (Reuters) - The euro and the currency bloc's government bonds yields inched lower on Wednesday as investors waited on euro zone inflation data that, if weak, would increase pressure on the European Central Bank to act when it meets next week.

A preliminary reading due at 0900 GMT (5 a.m. EDT) is expected to show inflation at 0.8 percent in April, up from March's 0.5 percent but still well below the ECB's medium-term target of just below 2 percent. Anything less would sharpen the market's focus on ECB policy.

The euro inched down to $1.3802 in the pre-data jockeying, having fallen fairly sharply on Tuesday on the back of a weaker-than-expected 1.1 percent German inflation reading.

ECB head Mario Draghi said last week that if the inflation outlook were to deteriorate, the ECB could respond with a "broad-based asset purchase program", probably quantitative easing, or QE - effectively, printing money to buy assets.

On Monday, however, he told lawmakers from Germany's ruling coalition that while low inflation would persist in the euro zone, he did not expect deflation, according to a source who attended the meeting.

"The market is broadly expecting a bounce in inflation so the stronger reaction would be if it surprised to the downside," said Alvin Tan, a currency strategist at Societe Generale.

"If it comes in below 0.6 (percent) the pressure will rise on the ECB to do something next week. We doubt that there will be QE (quantitative easing) in the near term. The most likely is some liquidity measures and increased dovish rhetoric."

The ECB meets in Brussels next Thursday.

Euro zone government bonds across the spectrum from Germany and France to Greece and Portugal gained ground in early trading on hopes that lower ECB rates would make their yields relatively more appealing for investors again.

European stocks took a breather, having jumped to a near four-week high on Tuesday thanks to combination of strong earnings, company takeovers and relief at the mild tone of sanctions imposed on Russia by the West.

Shares in French conglomerate Alstom jumped 8 percent, though, after it said it would review an offer from General Electric for its energy business and left the door open for a rival bid from German giant Siemens .

FED MEETING

Overall, caution dominated ahead of the outcome of a Federal Reserve's policy meeting later in the session as well as U.S. jobs data on Friday, and against a backdrop of continuing tension in Ukraine.

Asian shares had struggled while the yen strengthened after upbeat Bank of Japan economic projections suggested no additional stimulus was on the near-term horizon.

Japan's Nikkei stock average rose on Wednesday but logged a drop of 3.5 percent in April while China's yuan completed its fourth straight month of losses as it ended April at an 18-month low.

Later on Wednesday, Fed officials are expected to decide unanimously at the conclusion of their two-day meeting to continue tapering the central bank's massive bond-buying stimulus. Investors will focus on what their statement implies about the monetary policy outlook.

"Fed policy is basically on cruise control while the Committee waits to see how the economy rebounds from the cold weather, how the labor market is progressing, and whether inflation returns to more normal levels," Marshall Gittler, head of FX strategy at IronFX Global, said in a note to clients.

MIXED SIGNALS

Ahead of the euro zone inflation data, the ECB published its latest quarterly bank lending survey. After a disappointing euro zone credit reading on Tuesday it painted a more upbeat picture with banks sensing easier conditions ahead.

Figures from Madrid earlier also showed Spain's economy saw its strongest quarterly growth in six years in the first quarter of the year although retail sales both there and in Germany sagged last month.

Market participants continued to track developments in Ukraine, where hundreds of pro-Moscow separatists stormed government buildings in a provincial capitals on Tuesday and fired on police holed up in a regional headquarters.

The dollar shed about 0.3 percent against the yen to 102.37 yen, striking a session low of 102.28 yen soon after the BOJ revealed its upbeat forecasts, and moving away from a three-week high of 102.79 yen hit on Tuesday.

In commodities trading, spot gold slipped 0.2 percent to $1,292.90 an ounce.

U.S. crude slipped 1 percent to $100.32 per barrel, on expectations that U.S. inventories would hit the highest level on record.

(Reporting by Marc Jones; Editing by John Stonestreet)