By Stella Qiu

SYDNEY Asian shares struggled for traction and the dollar was subdued as the market focuses on the probability of a less aggressive Federal Reserve at its policy meeting which concludes on Wednesday.

The Fed is widely expected to hold off on raising rates after a softer U.S. inflation report and investors' cautious mood is likely to extend to Europe when markets open.

The pan-regional Euro Stoxx 50 futures is down 0.2%. Both S&P 500 futures and Nasdaq futures were flat, after U.S. stocks rallied to 14-month highs overnight.

In Asia, MSCI's broadest index of Asia-Pacific shares outside Japan were last 0.2% lower, after surging 1.1% in the prior session to the highest in two months.

Tokyo's Nikkei, however, continued to outperform, jumping 1.6% to a fresh 33-year high, as investor cheered the return of inflation amid the accommodative policy stance from the Bank of Japan.

Chinese blue chips rose 0.2%, marking the fifth straight session of gains and pulling away from 2023 lows, on hopes for more economic stimulus. Hong Kong's Hang Seng index was, however, 0.4% lower amid concerns about whether the stimulus would be enough to revive a faltering economy.

Analysts polled by Reuters expect China's central bank to cut the borrowing cost of medium-term policy loans for the first time in 10 months on Thursday, following a reduction in a short-term policy rate.

Overnight, the much-watched U.S. CPI report showed prices barely rose in May, with just a 0.1% increase from the prior month. On an annual basis, consumer prices rose 4%, the smallest in more than two years, slowing from April's 4.9%.

That led traders to firm up expectations of a rate pause by the Fed to 94% when it concludes a two-day policy meeting on Wednesday, but they are also bracing for the possibility of a hawkish surprise, with a 60% probability priced in for a hike in July, according to CME FedWatch Tool.

"While the soft headline inflation print gives the Fed the go-ahead to pause its rate hiking cycle on Thursday, sticky core inflation will keep the Fed's hawkish trigger finger hovering over the rate hike button in the months ahead," said Tony Sycamore, a market analyst at IG.

Perhaps reflecting some of those concerns, two-year Treasury yields hit 4.7070% overnight, the highest since March, before easing 4 basis points to 4.6519% in Asian hours.

The benchmark 10-year yields also climbed to the highest in 2-1/2 weeks at 3.8450%. They were last down 3 basis points to 3.8056%.

"We think it will be a hawkish pause as the Fed emphasises that the hiking cycle might not be done. Whether the pause turns into a skip will depend on incoming data," said Eugene Leow, senior rates strategist at DBS Bank.

Persisting inflation pressures elsewhere are keeping markets jittery. Data showing a rapid pickup in UK wage growth in the three months to April could complicate matters for the Bank of England, which is set to debate its monetary policy decision next week.

Short-dated German yields jumped to a 3-month high overnight as investors looked to the rate decision from the European Central Bank on Thursday. It is expected to raise rates by another quarter-point and again in July before pausing for the rest of the year.

The U.S. dollar remained pressured in a narrow range on Wednesday at 103.29 against its major peers, just a touch above a three-week low that it hit overnight.

The euro was hovering at $1.0789 after hitting a three-week top of $1.0823 overnight, while sterling settled at $1.2607, nearing a one-month high of $1.2625 reached on Tuesday.

Oil prices reversed earlier losses after receiving a 3% boost on China's policy rate cut. U.S. crude futures steadied at $69.42 per barrel, while Brent crude futures rose 0.2% to $74.41 per barrel. [O/R]

Gold prices were 0.3% higher at $1,948.48 per ounce.

(Reporting by Stella Qiu; Editing by Shri Navaratnam and Jacqueline Wong)