By Tom Wilson
LONDON (Reuters) - European stocks fell on Tuesday and bond yields jumped after a pick up in euro zone business activity this month fuelled predictions that the European Central Bank would remain hawkish as inflation stays stubbornly high.
Euro zone business activity gathered steam, expanding much faster than thought, according to a survey, buoyed by a growth in services even as the manufacturing sector shrank.
Germany's 2-year bond yield, which is the most sensitive to interest rate expectations, hit a 14-year high of 2.95%. It was last up 3 basis points at 2.923%.
The Euro STOXX 600 fell as much as 1% before clawing back some of its losses, and was last down 0.4%. German and French shares also lost about 0.3% respectively.
Also weighing on Europe's benchmark index was Europe's biggest bank HSBC Holdings Plc, which fell 1% on a cautious outlook even as its quarterly profit surged.
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"The combination of better-than-expected economic activity at the start of the year and service sector inflationary pressures which remain elevated will likely keep the ECB in hawkish mode," analysts at ING wrote in a note.
The data failed to budge the euro, which remained 0.2% lower at $1.067, on course to end February lower and break four straight months of gains. It has lost nearly 2% against the U.S. dollar so far in February.
Other flash PMIs painted a positive picture of economic activity in Europe.
German business activity returned to growth for the first time in eight months in February, while France's PMI showed activity grew this month for the first time since October.
The British pound, meanwhile, gained 0.4% against the dollar to $1.2088 and firmed versus the euro after UK PMI data showed an unexpected bounce in British business activity, giving hope that the economy could sidestep a deep recession.
The PMI data, closely watched by investors for pointers towards the future shape of monetary policy, came at a key time for equity markets, whose strong start to the year after a bruising 2022 has stalled in February.
"We are at a pivotal moment, where investors are thinking about restarting some positions," said Francesco Sandrini, head of multi-asset strategies at Amundi. "These numbers are really important."
The MSCI world equity index, which tracks shares in 47 countries, fell 0.2%.
U.S. flash February PMI data is due later in the day. Wall Street was set for slim losses with e-mini futures for the S&P 500 last down 0.7%.
Investor focus is also firmly on the release on Wednesday of the minutes of the Fed's latest meeting earlier this month when it raised interest rates by 25 basis points.
The dollar index, which measures the U.S. currency against six other rivals, was last at 104.11, just below a six-week high of 104.67 touched on Friday.
The market is now pricing U.S. interest rates to peak at 5.30% in July and remain above 5% by the end of the year, moving away from expectations of deeper rate cuts this year. The yield on 10-year Treasury notes was up 2.3 basis points to 3.852%, after touching a three-month high on Friday. The yield of the two-year U.S. Treasury paper, which typically moves in step with interest rate expectations, was up 3.5 basis points at 4.658%.
"There is a chance that the European economy proves more resilient than the U.S.," said Mike Bell, global market strategist at J.P. Morgan Asset Management, adding that it remained unclear whether growth in euro zone would be able to stay insulated from any U.S. slowdown.
Earlier, Asian stocks slid, with MSCI's broadest index of Asia-Pacific shares outside Japan losing 0.9%.
Japan's manufacturing activity shrank at the fastest pace in 30 months in February, amid weakening demand and a struggle to tame cost pressures. The Nikkei closed down 0.2% lower.
(Reporting by Tom Wilson in London and Ankur Banerjee in Singapore; Editing by Shri Navaratnam, Himani Sarkar and Christina Fincher)
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