HONG KONG -- Oil prices extended losses Wednesday on fears of waning energy demand, buoying Asian stocks and weighing on bond markets as investors searched for higher returns.

European stock markets latched on to the rally and opened more than 1.0 percent higher.

The dollar held gains made the previous session after top US officials, including Treasury Secretary Henry Paulson, gave it a verbal lift.

Crude oil futures fell 0.5 percent to $127.75 a barrel after having closed on Tuesday at the lowest since June 5 on worries that record oil prices were stunting economic growth.

Oil prices have tumbled some $20 since hitting an all-time high just two weeks ago, easing immediate concerns about the burden of high energy costs, though soft consumer demand continues to be a worry.

On the earnings front, with the results from some Wall Street banks not as dire as analysts had predicted, investors broadened their focus to other sectors, with announcements on Friday expected from Samsung Electronics Co. Ltd. and Honda Motor Co.

"We're just seeing a temporary bright patch," said Yoku Ihara, manager of the investment information department at Retela Crea Securities in Japan. "It's still far too early to let down our guard."

Japan's Nikkei share average rose 1.0 percent to the highest in two weeks. The Nikkei had back-to-back gains of at least 1.0 percent for the first time since April.

Outside of Japan, shares in the Asia-Pacific region climbed 2.2 percent to the highest in three weeks, according to an MSCI index.

Hong Kong's Hang Seng rose 1.9 percent to a one-month high.

Despite investors' increasing willingness to buy riskier assets lately, high inflation continues to stalk Asian markets.

The combination of rising price pressures and slowing growth was a big factor in the nearly $4.0 trillion in market capitalization that has evaporated since November, Morgan Stanley said.

Underlying inflation in Australia was at the highest in almost 17 years in the second quarter, suggesting the central bank may have to keep interest rates where they are despite threats to growth.

Consumer prices in Vietnam, whose stock market is one of the worst performers this year, are expected to rise 25 percent this year, double last year's pace, with the country seen running an $18.8 billion trade shortfall, a state-run newspaper said.

VALUATIONS PROVIDE SUPPORT

JPMorgan slashed its 2008 targets for Asia-Pacific stock markets across the board on Wednesday by an average of 13.5 percent, though it still was looking for double-digit 12-month returns from every country in the region, excluding Japan.

Cheap valuations will likely support equity prices over the next year, with top three most inexpensive markets tracked by JPMorgan's valuation model -- Taiwan, Philippines, Australia -- located in Asia, the bank said.

"The consensus return-on-equity forecasts for the next three years are much higher than the historic average for each market," said Adrian Mowat, JPMorgan's chief equity strategist for emerging markets and Asia Pacific.

"While this indicates a high degree of optimism it can also be argued that this suggests that the risks to valuations are on the upside," he said in a note.

Yields on safe-haven government bonds, which move inversely to prices, edged higher as the MSCI all-country world equities index appeared poised for a sixth straight day of gains, the longest string since May.

The benchmark 10-year US Treasury yield ticked up to 4.11 percent, up two basis points from late Tuesday in New York and 9 basis points higher on the year.

The 10-year Japanese government bond yield rose 3.5 basis points to 1.645 percent.

The US dollar stayed firm, holding much of the ground gained against the euro and yen the previous day after Paulson said a strong dollar was "really very important," a variation on his usual comments about the currency.

"The dollar broke through some key levels and has upside momentum," said Motonari Ogawa, director of forex trading at Barclays Bank in Tokyo. "But Japanese exporter selling could emerge at these levels, and it won't be a one-way rise for the dollar," said Ogawa.

The dollar rose 0.4 percent at 107.67 yen. The euro slipped 0.1 percent to $1.5775 and up 0.3 percent against the yen at 169.85 not far from a record high 169.91 yen hit on Monday.