(Adds dropped word in headline)
* US bond yields, dollar rise
* Fed rate expectations strengthen
* Stocks capped, German banks in focus
By Jamie McGeever
LONDON, Aug 31 (Reuters) - Bond yields rose on Wednesday, with 10-year U.S. Treasury yields on course for their biggest monthly rise in over a year as investors continued to build up bets that the Federal Reserve will raise interest rates before the year is out.
The growing prospects of a rate hike, perhaps next month, lifted the dollar against many major currencies, pushing it up to a one-month high against the Japanese yen.
The increase in market-based rates and a firm dollar kept a lid on world stock. Japan's Nikkei 225 bucked the trend, however, its 1 percent rally driven by the yen's fall to a one-month low.
U.S. futures pointed to a slight decline at the open on Wall Street and Europe's main bourses hovered close to flat in early trading.
The notable gainer was German bank Commerzbank, whose shares rose as much as 4 percent after a German magazine reported that the country's biggest lender Deutsche Bank had in the past considered the idea of a merger with Commerzbank.
Deutsche boss John Cryan, however, poured cold water on the idea, erasing some of the gains in Commerzbank shares.
"Markets remain reluctant to price in a high probability of a Fed rate hike as soon as 21 September, but such a stance is too dovish in our view," BNP Paribas strategists wrote in a note to clients on Wednesday.
This leaves open the prospect of a "significant" rise in short-term U.S. yields if the August employment data on Friday is strong enough to pave the way for a rate hike at the Fed's next policy meeting, they added.
Benchmark 10-year U.S. Treasury yields were up 1 basis point at 1.58 percent, bringing the increase over August up to 12 basis points, the most since June last year.
Two-year yields, which are more sensitive to near-term rate hike expectations, were also up 1 basis point at 0.81 percent . They have risen nearly 15 basis points this month, the most since November last year.
Friday's U.S. jobs report is expected to show employers added 180,000 jobs in August, according to the median estimate of 89 economists polled by Reuters.
Fed Vice Chairman Stanley Fischer said in an interview on Tuesday that the job market is nearly at full strength and the pace of interest rate increases will depend on how well the economy is doing.
On Wednesday Chicago Fed President Charles Evans highlighted sluggish growth and the case for keeping rates lower for longer, while Boston Fed president Eric Rosengren said higher rates could shield the economy from risks such as a commercial real estate bubble.
As of Tuesday, markets were pricing in a 24 percent chance of a U.S. rate hike next month, according to CME Group's FedWatch tool, and a more than 50-50 chance of higher rates by the end of the year.
U.S. consumer confidence rose to an 11-month high in August, with households more upbeat about the labour market, data showed overnight.
The dollar rose a third of one percent against the yen to a one-month high of 103.34 yen, and the euro slipped to $1.1130.
"It's finely balanced and remarkably stable ... and yet dollar/yen moved higher again, setting the scene for the Japanese equities bounce overnight," Societe Generale FX strategists said on Wednesday, adding that the dollar would have to break above 105 for this move to look like much more than "noise".
The FTSEuroFirst index of leading 300 shares was up 0.1 percent at 1,358 points, Germany's DAX was down 0.1 percent and Britain's FTSE 100 was up 0.1 percent .
MSCI's broadest index of Asia-Pacific shares outside Japan was down 0.35 percent and global stock index was flat.
On Wall Street on Tuesday, markets logged losses, dragged down by shares of Apple Inc after antitrust regulators ordered the company to pay about $14.5 billion in back taxes to the Irish government.
Crude oil futures continued to slip on Wednesday after ending down for a second straight day on Tuesday, on worries of oversupply and a strong dollar.
Brent crude slipped 0.8 percent to $48.00 per barrel after shedding 1.8 percent on Tuesday, but remains on track for a healthy 13 percent gain in August.
U.S. crude was down 0.5 percent at $46.12 after losing 1.3 percent overnight. It is set to end the month 11 percent higher.
Spot gold edged up 0.3 percent to $1,313 an ounce after tumbling to as low as $1,308.65 on Tuesday, its lowest since late June, pressured by the stronger dollar and growing expectations of higher U.S. rates. It is headed for a 2.7 percent decline in August.
Reporting by Jamie McGeever; Editing by Raissa Kasolowsky