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Asian stocks rally sputters as China pulls back, higher U.S. yields weigh

A person walk near an electronic stock board showing Japan's Tokyo Stock Price index at a securities firm Thursday, March 2, 2023, in Tokyo. ...

A person walk near an electronic stock board showing Japan's Tokyo Stock Price index at a securities firm Thursday, March 2, 2023, in Tokyo. ... (AP photo)

SYDNEY, March 2 (Reuters) - A rally in Asian shares sputtered on Thursday, pressured by a pullback in Chinese stocks and higher U.S. yields amid fears the Federal Reserve will keep raising interest rates to combat sticky inflation.

European markets are likely to open flat, with pan-region Euro Stoxx 50 futures STXEc1 largely unchanged, as caution set in ahead of the release of European inflation data for February.

Median forecasts are for an annual figure of 8.2%, but risks are on the upside following surprises from France, Spain and Germany.

In Asia, MSCI's broadest index of Asia-Pacific shares outside Japan .MIAPJ0000PUS lost 0.4%, unwinding some of the 2.1% gain in the previous session - the index's best day in two months. Japan's Nikkei .N225 was largely flat.

Hong Kong's Hang Seng Index .HSI retreated 0.8%, after registering its biggest daily gain in nearly three months on Wednesday when it jumped 4.2% on the back of unexpectedly robust readings from China PMI surveys.

Investor enthusiasm has faded somewhat over China's economic reopening after Beijing dismantled its strict COVID-19 controls in December, as analysts look for more evidence to gauge the pace of economic recovery.

China's annual meeting of the National Party Congress may provide more stimulus clues when it kicks off this weekend to set economic targets and elect new top economic officials.

"Financial markets are caught between the two narratives of a softer landing, helped by China's reopening, and sticky inflation keeping policy rates higher for longer," said Chris Turner, global head of markets at ING.

"That will probably keep bond markets on the back foot and FX markets volatile in ranges."

S&P 500 futures ESc1 fell 0.5% and Nasdaq futures NQc1 were off 0.6%, pressured by a 5.5% drop in Tesla shares TSLA.O in after-hour trading. The company will cut vehicle assembly costs by half in future generations of cars, but Chief Executive Elon Musk did not unveil a much-awaited small, affordable electric vehicle.

Overnight, both bonds and shares took a battering, as inflation indicators from Germany and the United States reinforced expectations interest rates would go higher and stay there for longer.

Germany's 2-year government bond yield DE2YT=RR rose to its highest since October 2008.

In the United States, manufacturing activity contracted for a fourth straight month in February, but a gauge of prices for raw materials increased last month, stoking concerns that inflation would remain stubborn.

"The PMI manufacturing data provides a mixed message for global risk appetite, with improving growth trends positive, but lower output prices stalling out," said Alan Ruskin, macro strategist at Deutsche Bank.

Benchmark 10-year Treasury yields US10YT=RR hit a fresh four-month high of 4.028%, while two-year yields US2YT=RR also advanced to 4.9310%, a fresh 15-year high.

Investors still mostly foresee the Fed raising rates by 25 basis points at its next meeting later this month, but expectations of a larger 50 basis points hike have increased. The probability that the Fed's policy rate, currently set in the 4.5% to 4.75% range, could peak above 5.5%, stood at 53%, compared with 41.5% on Feb. 28, according to CME Fed tool.

Minneapolis Fed President Neel Kashkari said he was inclined "to push up my policy path" after a recent government report showed the Fed's preferred inflation index accelerated in January to a 5.4% annual rate, more than double the Fed's 2% target and slightly faster than the month before.

In currency markets, the U.S. dollar =USD index, measuring the greenback's value against a basket of major peers, gained 0.2% to 104.62.

The euro EUR=EBS lost 0.2% to $1.0641, reversing some of a 0.8% gain overnight, with hotter-than-expected German inflation adding to pressure on the European Central Bank to raise rates.

In the crypto world, shares in Silvergate CapitalSI.N plunged by as much as 28% after the cryptocurrency-focused bank said it was delaying its annual report and was evaluating its ability to operate as a going concern.

Oil prices were largely steady on Thursday, having risen by 1% the previous day due to optimism over China's recovery. U.S. crude CLc1 held at $77.72 a barrel. Brent crude LCOc1 was largely unchanged at $84.38 per barrel.