By Richard Hubbard
LONDON (Reuters) - Signs of progress on the fiscal standoff in Washington helped lift the dollar off an eight-month low on Tuesday, but lingering fear of any U.S. debt default weighed on world shares and oil.
A White House spokesman said on Monday it would accept a short-term increase in the nation's borrowing authority to avoid a default. An influential senator was also said to be floating a plan to cut federal spending and reform the U.S. tax code as part of a broader deal.
As the partial U.S. government shutdown enters a second week, investors still believe Republicans and Democrats can reach deals on the budget and the debt ceiling.
But they remain wary of the risk of failure.
"Everyone thinks it will get resolved, but the fear is that at the last minute it might not," Greg Matwejev, director of FX Hedge Fund Sales and Trading at Newedge, said.
The uncertainty kept the MSCI world equity index <.MIWD00000PUS>, which tracks shares in 45 countries, within a narrow range with U.S. stock index futures pointing to a similarly flat start on Wall Street when it opens later. (.N)
The stability of riskier assets in the face of the potential threat of a U.S. debt default, which would cause massive turmoil on global financial markets, has also encouraged some investors to expect a big relief rally if a deal gets done.
"I'm prepared to step out at any time should it come crashing down, but for the moment I'm still betting on the upside," said Andreas Clenow, hedge fund trader and principal of Zurich-based ACIES Asset Management.
"Equities have held up remarkably well given what's going on. If that's not a strong sign, I don't know what is."
Brent crude oil, another asset seen as a riskier investment, edged above its recent range of $109-$110 to $110.40 a barrel, although analysts said it could be gaining from the withdrawal of financial investors who wanted to sell.
"Oil is still doing surprisingly well, given the ongoing budget crisis in the U.S., the approach of the debt ceiling and mounting supplies," said a Commerzbank research note.
"Nevertheless, we suspect that the latest show of strength on the part of oil is only temporary."
The dollar did get some support from the signs lawmakers were taking steps to try to end the deadlock, gaining 0.4 percent against the perceived safe haven of the yen to 97.10 yen. Though this only took place after the greenback had dropped to 96.55 yen, its lowest since August 12.
The dollar index, which measures the U.S. currency's value against a basket of currencies, (.DXY), was still within striking distance of last week's eight-month low of 79.627 and traders said it remained vulnerable to further selling.
The longer the political deadlock runs, the greater the expected economic damage and the more likely it becomes that the Federal Reserve will continue for longer a stimulus programme that has flooded global markets with dollars.
America's biggest creditors, China and Japan, have also said they are increasingly worried that the developments in Washington could wreak havoc on their trillions of dollars of investments in U.S. Treasury bonds.
"The risk is to the downside for the dollar as long as we don't have an agreement," said Niels Christensen, currency strategist at Nordea.
European equities traded lower after ending in negative territory for three of the last four trading sessions. The broad FTSE Eurofirst 300 index (.FTEU3) dipped 0.2 percent.
The U.S. anxiety - and the broadly softer dollar - has helped support gold, which extended gains into a second day on Tuesday to trade up 0.3 percent at $1,325 an ounce.
Gold also saw some support from Chinese buyers returning after a week-long National Day holiday. China is the world's second-biggest gold consumer after India. (GOL/)
The worries over the U.S. fiscal impasse largely overshadowed data from China showing business confidence in the countries services sector had slipped in September though the economy remained on course for expansion.
Copper prices, which are very sensitive to Chinese data due to the country's heavy demand for the metal, was slightly firmer, up 0.45 percent at $7,279 a tonne, though within the $7,000-$7,500 a tonne range seen since early August.
(Additional reporting by Sudip Kar-Gupta and Jessica Mortimer. Editing by)