World stocks tread water as traders eye Fed pause prospects

European stocks started Tuesday mixed, as soft US economic data reinforced expectations the Federal Reserve may skip an interest rate hike when it meets next week.

The pan-European STOXX 600 index (.STOXX) was up 0.1% to 460.40 at 0830 GMT. In the previous session, the index dropped as data pointing to tepid U.S. business activity sparked profit-taking following gains in the prior week. Germany's DAX (.GDAXI) was flat, while London's FTSE dipped 0.3% (.FTSE).

British retail sales growth slowed to a seven-month low in May as soaring food prices prompted shoppers to rein in spending on non-essential items, the British Retail Consortium said on Tuesday.

MSCI's broadest index of world stocks (.MIWD00000PUS) was largely flat, while Tokyo's Nikkei (.N225) gained 0.90% and China's blue-chip index (.CSI300) dropped almost 1%.

The Reserve Bank of Australia (RBA) raised interest rates and warned that further hikes may be required to ensure inflation returns to target. The RBA's move sets the stage for a slew of monetary policy decisions from major central banks across the globe, with the Fed, the European Central Bank and the Bank of Japan due to hold policy meetings next week.

Three months ago, the question was how fast would rate hikes come. Now, a pause and then more U.S. rates hikes could follow as a result of sticky inflation, said Mike Kelly, head of multi-asset at PineBridge Investments.

"We're actually still positioned on the notion that you can get a mild US recession without pulling the world into recession," he said.

A string of economic data along with last week's dovish rhetoric from Fed officials has emboldened bets that the Fed will likely refrain from lifting rates at its June 13-14 meeting.

Markets are pricing in an 82% chance of the Fed standing still, a sharp jump from a 36% chance a week earlier, according to the CME FedWatch tool.

Data overnight showed the US services sector barely grew in May as new orders slowed, pushing a measure of prices paid by businesses for inputs to a three-year low, which could aid the Fed's fight against inflation.

The services industry accounts for more than two-thirds of the US economy.

"The index sends another signal that demand is cooling and that the cumulative tightening is working through the economy, giving room to the Fed to pause in June to assess conditions further," Saxo Markets strategists said in a note to clients.

Data on Friday showed US non-farm payrolls rose by 339,000 in May, but a surge in the unemployment rate to a seven-month high of 3.7% suggested an easing in labour market conditions.

"The tactical risk for equity investors in the very near term is that the Fed indeed skips a meeting and raises rates in July and not June," said Gary Dugan, CIO of Dalma Capital.