GLOBAL MARKETS-U.S. shutdown hits dollar but most investors keep calm

Reuters

* Dollar slides as U.S. government pauses some services

* Equity, debt mostly firmer, anticipating early resolution

* Gold edges higher on limited safe haven demand

* Italian debt falls before key government vote

By Richard Hubbard

LONDON, Oct 1 (Reuters) - The first American governmentshutdown in 17 years weakened the dollar on Tuesday, sending itto an eight-month low against the euro, but otherwise leftequity markets firmer while U.S. Treasury bonds fell.

Investors saw the shutdown as likely to be temporary, andalso as a factor that could further delay the U.S. FederalReserve's plans to start scaling back its monetary stimulus.

U.S. Federal government agencies have begun a partialshutdown after lawmakers failed to pass a temporary spendingbill before a midnight deadline, threatening the salaries of upto a million workers.

"We do not know how long this impasse in the U.S. will last.If it persists, there is a chance it will hurt economic growthand affect chances of Fed tapering," said Daragh Maher,strategist at HSBC.

The dollar bore the brunt of the response, hitting a 1-1/2year low against the safe-haven Swiss franc and a near8-month low against a basket of widely-traded currencies.The falls lifted the euro to an 8-month high of $1.3589.

"In the short term, it's better to avoid the dollar," Mahersaid.

However, U.S. stock index futures pointed to gains when WallStreet opens later with the broad S&P stock contract edging up 0.4 percent. The price of the 10-year U.S. Treasurynote, a bedrock reference for bond markets, has fallen, liftingthe yield 3 basis points to 2.645 percent.

Europe's broad FTSEurofirst 300 index, extending astellar performance in the September quarter, inched up 0.3percent though was not far from a three-week low.

MSCI's world equity index, which tracksshares in 45 countries, was up 0.2 percent by midday in Europe,helped by gains in Asia after investors anticipating the newshad triggered its biggest daily fall of September on Monday.

"The U.S. shutdown is a central point for the markets, butas long as the hope for just a temporary shutdown exists, itwill not be a strong burden for equities," Christian Stocker,equity strategist at UniCredit said.

Gold, another traditional safe haven asset, popped higherafter the shutdown became apparent, hitting $1,331.50 an ounce,though was well within its recent $1,300 to 1,350 range.

CEILING LOOMS

The bigger issue facing investors is the implications of thepolitical dysfunction in Washington for this month'snegotiations on raising the U.S. government's $16.7 trillionborrowing limit, needed to avoid a default on its debt mountain.

"The real focus for markets is Oct. 17 when the debt ceilingissue will come to the fore again," said Richard Lewis, head ofglobal equities at Fidelity Worldwide Investment.

"This is going to be much more important because a failureto extend the debt ceiling would stop coupon payments on bonds,creating a technical default that would cause a riot in bondmarkets," he said in a note.

Markets were also absorbing mixed readings on economicactivity across the manufacturing sector for September and a promise of a $50 billion stimulus package by Japan's government,designed to offset the impact of a sales tax hike next April.

Japan's move came after a closely-watched central banksurvey showed sentiment among domestic manufacturer's had improved sharply in the three months to September to reach anear six-year high.

A separate euro zone factory activity survey revealedgrowth, albeit at a slower pace than previously. In China,factories expanded only slightly last month, raising questionsover the strength of its nascent recovery.

ITALY STABILISES

Italian bonds rose a day before Prime Minister Enrico Lettawas due to face a vote of confidence intended to resolvetensions threatening the ruling coalition.

The yield on the benchmark 10-year Italian government bondfell 2 basis points at 4.55 percent though traderssaid talk of further liquidity support from the European CentralBank could also be helping.

The ECB holds a policy meeting on Wednesday and is expectedto stick to its accommodative policy course..

Brent crude fell to near $108 a barrel, not far from a7-week low, on worries that the U.S. government shutdown maycrimp oil demand. U.S. crude was at $102.29, down 5cents.

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