By Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) -The European Central Bank is all but certain to raise borrowing costs to their highest level in 22 years on Thursday and leave the door open to more hikes, extending its fight against high inflation even as the euro zone economy flags.

Growth across the 20 countries that share the euro is at best stagnating and inflation has been moderating for months, courtesy of lower energy prices and the steepest increase in interest rates in the ECB's 25-year history.

Furthermore, the U.S. Federal Reserve broke a string of 10 successive rate hikes late on Wednesday, a powerful signal for investors around the world that the current tightening cycle across developed economies is nearing an end, even if more U.S. rate hikes are still possible.

But inflation in the euro zone is still unacceptably high for the ECB at 6.1% - more than three times its 2% target - and underlying price growth, which typically excludes food and energy, is only starting to slow.

That is likely to keep the ECB on the tightening path, particularly after it failed to predict the current bout of high inflation and began raising rates later than many global peers last year.

"They simply cannot afford to mess it up once again," said Carsten Brzeski, the global head of macro at Dutch bank ING.

The ECB is predicted to increase the deposit rate - the interest rate banks pay to park cash securely at the central bank - for the eighth consecutive time, by 25 basis points to 3.5%, its highest level since 2001.

Economists polled by Reuters expect another move of the same magnitude in July, a move a host of policymakers have already flagged, possibly to put pressure on colleagues going into Thursday's meeting.

While moves beyond July are less certain, ECB President Christine Lagarde is expected to keep a further hike in September in play and to push back against investor bets that the central bank will cut rates early next year.

"The bigger question is about the forward guidance," JPMorgan (NYSE:JPM) economist Greg Fuzesi said. "We are not convinced that the statement will signal or suggest that a July hike may be the last."

The Fed's pause was expected to temper ECB rate hike bets but investors actually pushed up their rate expectations overnight and now see the deposit rate peaking at 3.85%, suggesting that one more rate move after July is increasingly likely.

MIXED PICTURE

The ECB will update its economic forecasts, which are likely to put inflation closer to, but still above, 2% next year before it reaches the target in 2025.

While this would normally augur a pause in policy tightening, the ECB has been taking its own projections with a pinch of salt after years in which they missed the mark.

Instead, euro zone rate-setters have focused on actual economic data that have been painting a mixed picture.

Two quarters of contraction in industrial powerhouse Germany dragged the euro zone into a shallow recession last winter and the economy is likely to eke out only modest growth this year.

But unemployment is at record lows and wage growth is picking up, even if it still lags inflation.

Headline price growth has been falling fast after hitting double-digits late last year. But underlying prices, most notably for services, have yet to show the decisive drop ECB policymakers have said they would need to see before taking their foot off the monetary brake.

Higher borrowing costs are curbing demand for credit from households and companies as well as banks' willingness to lend, but consumption is holding up well in nominal terms.

These opposing factors were likely to provide ammunition to both sides of the ECB's Governing Council - the hawkish majority that has been pushing for more rate hikes and a minority of doves who have been advocating a pause.

As a result, economists expect the ECB to send out a more balanced message about the outlook than at recent meetings, when it stressed the need to raise rates further to cool demand.

"The ECB will probably emphasise even more strongly than before that its future policy path is data-dependent amid heightened uncertainty," economists at Berenberg wrote in a note to clients.

By Tetsushi Kajimoto and Kantaro Komiya

TOKYO (Reuters) -Japan's exports grew unexpectedly in May on robust car sales, though the rate of expansion slowed to a crawl as inflation and rising interest rates bit into global demand, highlighting a patchy recovery in the world's third-largest economy.

While the country's hotels, restaurants and other service sector companies have seen a boom in business since COVID curbs were eased, its factories have been struggling amid weakening demand for cyclical items such as chip-making machines.

Ministry of Finance data showed on Thursday that exports rose 0.6% year-on-year in May, for the 27th straight month of rises, led by 66% growth in car shipments.

The overall exports growth was the slowest since February 2021, but the outcome beat a 0.8% year-on-year decrease expected by 16 economists in a Reuters poll, and followed a 2.6% rise in April.

"Semi-conductor equipment and related exports were the main sources of export weakness, which chimes with the sharp drop in exports to countries like Taiwan and South Korea...offset by continued strength in motor vehicle exports," said Darren Tay, Japan economist at Capital Economics.

This year, domestic demand may temporarily outpace slumping exports as a key driver of growth, said Takeshi Minami, chief economist at Norinchukin Research Institute.

Separate government machinery orders data, also released Thursday, underlined the struggles faced by manufacturers though the overall numbers suggested the services sector is providing some cushion to the economy.

Core machinery orders rose 5.5% in April from the previous month, the first increase in three months and above the median forecast for a 3.0% gain. While orders from manufacturers were down 3.0%, an 11.0.% growth in service-sector demand for items such as computers drove up the headline figure.

On a year-on-year basis, core orders, a highly volatile data series regarded as a leading indicator of capital spending in the coming six to nine months, fell 5.9%, versus a forecast for a decline of 8.0%, the Cabinet Office data showed.

IMPORTS STILL WEAK

The data will be among other key indicators to be scrutinised by the Bank of Japan as it holds two-day policy setting meeting that ends on Friday.

Japan's gross domestic product (GDP) expanded an annualised 2.7% in January-March, much higher than a preliminary estimate of a 1.6% growth, as revised capital expenditures and firm private consumption more than offset the slowdown in external demand.

The trade data also showed imports fell 9.9% in the year to April, down for the second straight month on softening commodity prices, versus the median estimate for a 10.3% decrease.

The trade balance came to a deficit of 1.3725 trillion yen ($9.80 billion), versus the median estimate for a 1.3319 trillion yen shortfall.

By region, Japanese exports to China, the country's largest trading partner, fell 3.4% year-on-year in May for their sixth month of decrease, due to shrinking steel and auto parts shipment, although items such as cars and semiconductors recorded growth.

U.S.-bound exports, another key market for Japanese exports, grew 9.4% in the year to May on double-digit gain in car shipment.

"For the outlook of Japanese exports, the U.S. Fed's rate-hike pause is a positive news that will further vitalise American private consumption", said Kazuma Kishikawa, economist at Daiwa Institute of Research.

"With recovery in Chinese goods spending and easing supply bottlenecks for Japanese manufacturers, Japan's export volume will gradually pick up."

($1 = 140.0300 yen)

BEIJING (Reuters) - China's new home prices rose for the fifth straight month in May, but at a slower pace, according to official data on Thursday, as the government looks to shore up the crisis-hit property sector.

New home prices in May rose 0.1% month-on-month, slower than a 0.4% gain in March, according to Reuters calculations based on National Bureau of Statistics (NBS) data.

Prices rose for the first time since April 2022 in annual terms, up 0.1% from a 0.2% drop in April.

Beijing's broad-based stimulus measures to prop up the embattled property market since late last year had boosted sentiment in the wake of the abrupt end of COVID-19 curbs in December. But the sector is expected to grapple with "persistent weakness" for years, Goldman Sachs (NYSE:GS) analysts said this week, adding its problems would continue to drag on economic growth.

By Lucy Craymer

WELLINGTON (Reuters) -New Zealand's economy shrank in the first quarter as the central bank's aggressive hiking of interest rates to a 14-year high hurt businesses and manufacturers, while bad weather hit farms, putting the country into a technical recession.

Official data out on Thursday showed gross domestic product (GDP) fell 0.1% in the March quarter, in line with a Reuters poll, and followed a revised 0.7% contraction in the fourth quarter. With two quarters of negative growth, the country is now in a technical recession.

Annual growth slowed to 2.2%, Statistics New Zealand data showed. 

The March 2023 quarter included the initial impacts of Cyclones Hale and Gabrielle and teachers’ strikes.

"The adverse weather events caused by the cyclones contributed to falls in horticulture and transport support services, as well as disrupted education services," said Jason Attewell, economic and environmental insights general manager at Statistics New Zealand.

The weakness in the economy will not be seen as a negative by the central bank, which has said it needs economic growth to slow to dampen inflation and inflation expectations.

The contraction will likely add to expectations that the cash rate has now peaked, economists say.

The Reserve Bank of New Zealand has undertaken its most aggressive policy tightening since 1999, when the official cash rate was introduced, lifting it by 525 basis points since October 2021 to 5.50%. However, it has signaled that it has finished hiking.

Before the first-quarter GDP figures were released, the central bank had forecast the country would enter a recession in the second quarter of 2023, while Treasury's updated forecasts in May expected the country to avoid recession.

By Lucy Craymer

WELLINGTON (Reuters) - New Zealand needs to keep increasing the supply of houses to address housing affordability, which is still a concern, the International Monetary Fund said on Wednesday, adding that land should be freed up to promote investment.

“The cyclical downturn in (house) prices does not imply that the structural housing shortage has been addressed. There is a strong need to expand housing supply, including for social housing to improve affordability,” the IMF said in a statement issued after its "Article IV" review of New Zealand policies

New Zealand house prices have fallen roughly 16% since their peak in November 2021 as the central bank has aggressively hiked the cash rate with the intent of dampening inflation. However, New Zealand still has one of the highest house-price-to-income ratios in the world.

The IMF report said while prices have fallen, financial stability risks appear contained.

It added that achieving long-term affordability depends critically on freeing up land supply and improving planning and zoning, and fostering infrastructure investment to enable fast track housing developments and reduce construction costs and delays.

More broadly, the IMF said that New Zealand’s economic growth is expected to slow to 1% annually both this year and next while inflation will likely gradually decline to be between 1% and 3% by 2025.

“Risks to the outlook stem from the external environment and a potential need for stronger tightening of monetary and financial condition,” it said.

(Reuters) - French Finance Minister Bruno Le Maire will take a more stringent approach to public finances, he told the Financial Times ahead of a June 19 conference expected to unveil large cuts in public expenditures.

In an interview published on Wednesday, Le Maire promised a renewed push to cut public spending, saying France needed to stick to its debt reduction program after narrowly avoiding a downgrade by ratings agency S&P this month.

Although S&P retained its AA rating for France's sovereign debt, it stayed cautious about the outlook on account of strained public finances.

"The decision by S&P is an incentive to do more and to do better," Le Maire said. "We need to stick to our debt reduction program and to cut public expenditures."

France, its debt among Europe's highest, at nearly 110% of economic output, said last month it planned to freeze 1% of the budget of each ministry, following an earlier decision to cut 5%, in a bid to make good on deficit reduction commitments.

It will also end subsidies this summer for natural gas. Other areas being targeted are a buy-to-let tax credit known as the Pinel law and programmes that subsidise wages of some young workers, the paper said.

"As France nears full employment, it can also reduce the level of support to the labour market," Le Maire added.

However, the government would not cut public spending severely, he said, and push through business-friendly reforms instead.

"Austerity is not an option ...  This would be an economic and political mistake," Le Maire said.

SHANGHAI/SINGAPORE (Reuters) - China's central bank is widely expected to cut the borrowing cost of medium-term policy loans for the first time in 10 months on Thursday, after it lowered two key short-term policy rates, a Reuters poll showed.

The People's Bank of China (PBOC) cut its seven-day reverse repo rate and standing lending facility (SLF) rate by 10 basis points on Tuesday, signalling possible easing for longer-term rates to revive demand and restore investor confidence in the world's second-largest economy, analysts and traders said.

China remains an outlier among global central banks as it loosens monetary policy to shore up a stalling recovery but further rate cuts will widen the yield gap with U.S. assets and risk greater outflows.

In a poll of 33 market watchers conducted this week, all participants predicted that the central bank would lower the interest rate on one-year medium-term lending facility (MLF) loans when it is due to roll over 200 billion yuan ($27.92 billion) worth of such maturing loans on Thursday.

Among them, 31 or 94% of all respondents expected a 10-basis-point cut, while one predicted a 5-basis-point reduction and the other one forecasted a deeper cut of 15 basis points.

"As the open market operations (OMO) reverse repo rate moves in lockstep with the one-year MLF rate, which has become one of the most important benchmark rates in the PBOC's policy rate system, an OMO rate cut will almost surely be followed by an MLF rate cut, and the sequence of the two cuts matters less than the cuts themselves," said Ting Lu, chief China economist at Nomura.

The MLF rate serves as a guide to the benchmark loan prime rate (LPR), and markets usually use the medium-term rate as a precursor to any changes to the lending benchmark. The monthly fixing of the LPR will be announced on June 20.

"We expect a 10bp cut in the MLF rate on June 15, followed by an asymmetric cut in the LPR rates on June 20: a 10bp for 1-year LPR and 15bp for 5-year LPR," said Larry Hu, chief China economist at Macquarie.

"The cut is larger for the 5-year LPR, as it's linked to the mortgage rate. Looking ahead, we expect another 10bp cut in the MLF rate in 3Q23."

The PBOC last cut the MLF rate in August 2022 to prop up the broad economy disrupted by stringent zero-COVID measures.

($1 = 7.1626 Chinese yuan)

By Kevin Buckland

TOKYO (Reuters) - The dollar fell to near a three-week low to the euro and a one-month low versus sterling on Wednesday, after unexpectedly soft U.S. inflation data cemented the view that the Federal Reserve will skip an interest rate hike later in the day.

China's yuan sagged to a 6-1/2-month trough, continuing its slide after the central bank cut rates on Tuesday, amid speculation even more stimulus is on the way to support the sputtering post-COVID economic recovery.

The dollar index - which measures the currency against six major peers, including the euro and sterling - was little changed at 103.29 in early Asian trading, after dipping to the lowest since May 22 overnight at 103.04.

The U.S. consumer price index (CPI) edged up just 0.1% last month, and notched its smallest year-on-year increase since March 2021 at 4.0%.

That saw bets for a quarter-point hike to U.S. rates later on Wednesday pared to less than 6% currently, from 21% 24 hours earlier, according to the CME Group's (NASDAQ:CME) FedWatch Tool.

"The soft inflation report effectively cements a Fed pause, although I doubt it will be enough to warrant a dovish undertone as it's not in their interest with CPI twice the Fed's target," said Matt Simpson, senior market analyst at City Index, who points to 103 as a key support level for the dollar index.

"Whilst it was enough to send EUR/USD above 1.0800, it wasn't enough to keep it there given a hawkish pause seems quite likely."

The euro was little changed at 1.0791, after reaching a high of $1.08235 on Tuesday. The European Central Bank decides policy on Thursday, with a quarter-point rate hike widely expected.

Sterling edged 0.08% lower to $1.2602, but after soaring 0.8% in the prior session and hitting the highest since May 11 at $1.2625.

The dollar eased 0.16% to 140.02 yen. It rose to the highest since June 5 on Tuesday despite the soft U.S. inflation figures, with the Bank of Japan seen retaining ultra-easy policy settings on Friday.

The Australian dollar was flat at $0.6768, after reaching the highest since May 10 on Tuesday at $0.6807.

The Aussie garnered additional support from the People's Bank of China's decision to cut the seven-day reverse repo rate for the first time in 10 months on Tuesday. China is a key destination for Australia's resource exports.

The next adjustment to rates could come as soon as Thursday, when the central bank is due to roll over 200 billion yuan ($27.93 billion) in medium-term lending facility (MLF) loans.

The yuan weakened slightly and touched 7.1785 per dollar in offshore trading for the first time since Nov. 29.

By Jamie McGeever

(Reuters) - A look at the day ahead in Asian markets from Jamie McGeever, financial markets columnist.

Asian markets are set for an explosive open on Wednesday after a below-consensus reading of headline U.S. inflation lit the touchpaper for a rally across all risky assets on Tuesday, although investors will be mindful of the steep rise in U.S. bond yields.

The fall in U.S. inflation to a two-year low has convinced investors the Federal Reserve will pause raising rates on Wednesday, and they like what they see - the S&P 500, Nasdaq and MSCI World index all hit their highest levels since April last year, the dollar fell and cash flowed out of safe-haven bonds.

The rush into riskier assets was also supported by China's de factor policy easing as the central bank cut reserve repo rates for the first time in 10 months. This could be a precursor to lower benchmark interest rates in the coming weeks - yuan traders certainly seem to think so.

Indian wholesale price inflation, unemployment and import and export prices from South Korea, and New Zealand's first quarter current account top the Asian and Pacific data calendar on Wednesday.

India's annual WPI inflation could be especially important. Economists expect a fall of 2.35% in May, pointing to the strongest deflationary pressures in three years. With the year-on-year global oil price still down around 40%, it could be even lower.

But the driving forces for markets will likely be global.

Traders are putting a 95% probability on the Fed standing pat on Wednesday, a consensus so strong the Fed will almost certainly respect. The focus for investors will be on the statement and Fed Chair Jerome Powell's press conference for signs on whether it will be a 'hawkish' or 'dovish' pause.

All of that will come after Asian markets close, so in the meantime local investors will take their cue from yet another remarkable performance on Wall Street, especially tech stocks and the Nasdaq.

The NYSE FANG+ index of mega tech stocks rose 0.9% for a fourth consecutive daily rise, bringing its year-to-date gains to 72%. The index has posted only four declines in the past 21 trading sessions.

Even beleaguered Chinese tech stocks are finally feeling the glow - the Hang Seng tech index is up 11% so far this month, outperforming the broader Hang Seng (up 7%) and significantly outpacing the main Chinese indices, which are up 1% or 2%.

The MSCI Asia ex-Japan index rose more than 1% on Tuesday, its second best day since March, while Japan's Nikkei hit a fresh 33-year high above 33,000 points.

Momentum across all these markets is coming from strong technical, positioning and 'fear of missing out' tailwinds. One major headwind, particularly for Asian assets, could be the surge in U.S. Treasury yields, although that for now at least is being mitigated by the dollar's slide to a three week low.

Here are key developments that could provide more direction to markets on Wednesday:

- India WPI inflation (June)

- South Korea unemployment (May)

- New Zealand current account (Q1)

(By Jamie McGEever)

COLOMBO (Reuters) - Sri Lanka's government has decided to extend a restriction on outward capital transactions by six months due to pressure on its limited foreign exchange reserves, cabinet spokesperson Bandula Gunawardena said on Tuesday.

The decision will be revisited after debt talks are finalised in September, added Gunawardena, who is also the transport minister of the island country.