GLOBAL MARKETS-Stocks, dollar rally on hopes of U.S. debt ceiling deal

Reuters

* Dollar extends gains against yen, euro

* European shares open higher after rises in New York, Tokyo

* Gold extends losses

* Oil higher on kidnapping of Libyan PM

By Marc Jones

LONDON, Oct 10 (Reuters) - Shares and the dollar rallied onThursday as the first signs of progress towards ending thebudget and debt limit deadlock in Washington helped dial downfears of a calamitous U.S. default.

House Republican leaders will visit the White House later asefforts intensify to break the impasse that has left parts ofthe U.S. government shuttered for more than a week.

The dollar strengthened and was near a three-weekhigh against most major currencies by the middle of the Europeansession as recent U.S. lending market tensions also relaxed.

European stocks were strong too, up more than onepercent and on course for their best day in exactly a monthafter closing on Wednesday at their lowest since Sept. 5. WallStreet was expected to see similar gains when trading restarts .

Treasury Secretary Jack Lew was the first U.S. official tospeak on Thursday, warning that the standoff was stressingfinancial markets but that prioritising government payments justto avoid hitting the debt limit would be irresponsible.

UniCredit's Global Head of FX Strategy Vasileios Gkionakissaid positive signals for the dollar had been reinforced byminutes of last month's Federal Reserve meeting, published onWednesday. They showed its surprise decision not to startscaling back its stimulus was a close call.

"The Fed minutes reiterated that tapering (of monetarystimulus) will happen during this year ... but I think it (risein dollar) is largely that there are some discussions betweenthe Republicans and Democrats" over the debt ceiling, he said.

Both U.S. political parties floated the possibility onWednesday of a short-term increase in the country's $16.7trillion debt limit to avoid a default and allow time forbroader negotiations on the budget.

With the dollar heading up, the euro was already onthe back foot, and there was further pressure after both Frenchand Italian industrial production figures fell short ofexpectations.

Swedish industrial output also fell, a day after Britain'sdid the same, a reminder that the broader region's economicrecovery remains delicate.

The euro was hovering near a two-week low of $1.3500 versusthe dollar, while sterling dropped to athree-week low against the greenback and a five-week troughagainst the euro.

DEAL OR NO DEAL

With the U.S. government shutdown limiting the usual steadyflow of data, economists were eyeing the weekly release ofprivately compiled jobless claims data due at 1230 GMT for anyflavour of the impact the political deadlock is having.

In Asian trading, Tokyo's Nikkei share average advanced 0.9 percent to its highest in a week, while shareselsewhere lost ground.

Investors have expected the Republicans and Democrats to cuta deal by an Oct. 17 deadline to raise the debt ceiling, thougheach day that passes without an agreement tests their nerves.

It is unclear how long a short-term deal would be effectivefor, but any move to raise the borrowing limit would at leaststave off a possible default.

"It's a step forward for the market to resume risk-taking,though we are not too optimistic," said Isao Kubo, an equitystrategist at Japan's Nissay Asset Management. "Investors arecautiously buying back."

Strains in short-term U.S. interest rates and fundingmarkets have also increased as the deadline nears.

There were few signs of nerves on European bond markets,however, with German government bonds typically favoured byrisk-sensitive investors edging lower and higher-yielding eurozone periphery debt faring better.

BREATHING SPACE

News that the Federal Reserve's decision last month not toreduce its $85 billion-a-month bond-buying programme was a"close call" helped buoy the U.S. currency.

"This is consistent with our expectations that the Fed willtaper purchases at the upcoming December meeting," BarclaysCapital said in a note. "That said, the ongoing federalgovernment shutdown and upcoming expiration of the debt ceilingsuggests that the decision to taper could be pushed into 2014."

As the dollar regained its footing, gold eased 0.3percent to around $1,302.7 an ounce, adding to Wednesday's 0.9percent decline.

Oil rose on news Libya's prime minister had been seized byarmed gunman in a Tripoli hotel although he was later freed.

Brent headed towards $110 a barrel and U.S. crude prices added 0.5 percent to about $102.19 a barrel. U.S. priceshad tumbled 1.9 percent on Wednesday after the largest weeklybuild-up of U.S. stocks in a year added to the worries of amarket already concerned about the budget deadlock.

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