Asian Shares Inch Higher, Capped By European Political Uncertainty

A weaker-than-expected reading of consumer inflation in Australia, a day after a weaker producer prices report, set the scene for a local rate cut next week and bolstered local shares up 0.4 percent from a flat early trade.

MSCI's broadest index of Asia-Pacific shares outside Japan added 0.2 percent, after swaying between positive and negative territories for most of the morning. Japan's Nikkei average fell 0.5 percent.

The Australian dollar slid to a two-week low near $1.0264 from $1.0316 after Australian consumer prices increased by far less than expected last quarter and key measures of underlying inflation showed the smallest rise in over a decade.

(A rate cut's) probably a done deal now. The CPI number's so low, it's hard to argue against it now, particularly with what's going on in Europe, said Stephen Walters, chief economist at JP Morgan, adding that he expected a cut of 25 basis points was more likely than a 50 bps reduction.

Domestic-generated inflation is still very high. But certainly the prospects of them going (cutting) more than once is going up, the way the European situation's developing.

After a Sunday vote in France opened up the presidential race, Dutch Prime Minister Mark Rutte on Monday tendered his government's resignation in a crisis over budget cuts, creating a political vacuum in one of the euro zone's most stable nations.

Data showing the euro zone's business slump deepened at a far faster pace than expected in April further undermined risk appetite, sending U.S. stocks down over 1 percent and European equities to a three-month low on Monday.

Fragmented euro zone politics over austerity implementation is quickly becoming the disorder of the day, said Ashraf Laidi, chief global strategist at City Index.

The euro inched down 0.1 percent at $1.3147, slipping further away from a two-week high of $1.3225 reached on Friday. The yen held firm against the dollar at around 81.10 yen.

Overall, currency markets are in 'risk off' mode. That is to say, while the euro has not weakened that much (bearing in mind it is at the centre of the problem), the yen is stronger and higher-beta currencies softer across the board, Societe Generale said in a research note.

With concerns over sovereign debt restructuring rising, Dutch and peripheral euro zone bonds sold off on Monday, driving Spanish yields back above 6 percent and taking the spread of Dutch bonds over German benchmarks to the highest in three years.

As investors sought safety, the yield on five-year Japanese government bonds fell below 0.265 percent to a 18-month low early on Tuesday.

Oil prices recovered on Tuesday, with U.S. crude prices up 0.1 percent at $103.23 a barrel and Brent crude also up 0.1 percent at $118.86 a barrel.

Spot gold struggled, hovering around $1,636 an ounce as a shaky euro weighed.

Asian credit markets were sluggish on Tuesday, with the spread on the iTraxx Asia ex-Japan investment-grade index widening by about 3 basis points.

(Editing by Richard Pullin)