Fed, Euro Zone Concerns Weigh on Global Markets

Investors reacted with caution on Thursday to a relatively downbeat outlook from the U.S. Federal Reserve, sending world stocks lower and boosting the dollar in a search for safety.

Europe's debt crisis added to the mood, with a summit of European leaders beginning later in the day due to focus on the Greek bailout.

On the economic front, Germany's manufacturing growth eased in June.

The Fed said on Wednesday that while longer-term the U.S. economy should pick up, it was taking longer than predicted.

"The economic recovery is continuing at a moderate pace, though somewhat more slowly than (we) had expected," it said.

Financial markets responded by shifting away from riskier assets.

World stocks as measured by MSCI were down 0.6 percent, barely in positive territory for the year-to-date.

The FTSEurofirst 300 lost half a percent and Japan's Nikkei closed down a third of a percent.

"The downbeat Fed statement contained the end of QE2, little prospect of QE3, projections of slower growth and higher inflation," said Jonathan Sudaria, dealer at Capital Spreads.

The Fed is to complete its second asset-buying quantitative easing (QE) programme next week and although some investors are saying a third programme may be necessary there was nothing to suggest it in Wednesday's statement.

Investors were also reluctant to buy riskier assets ahead of a European Union meeting. Markets are looking for assurances that policymakers have a workable plan to help Athens avoid a debt default and return to financial stability.


The combination of worries about the global economy, which is still pretty much led by the United States, and the euro zone crisis, lifted the dollar.

It was up half a percent against a basket of major currencies .

"It's similar to last summer with flatter U.S. yield curves and a strengthening dollar in a risk averse environment," said Chris Turner, head of currency strategy at ING. "It looks like that trend will continue until U.S. data picks up or the Fed looks like it's going to do something."

On the euro zone government bond market, German debt prices rose after the manufacturing industry data.

"The economic backdrop remains supportive for bonds, although it is hard to disentangle in safe-haven bond markets the extent to which the periphery situation has added premium from the economic fundamentals impact," RBS rate strategists said in a note.

Spreads between peripheral euro zone debt yields and those of core German Bunds widened. (Written by Jeremy Gaunt; Editing by Anna Willard)