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

Reuters

* Wall St indexes rise 1 pct, European shares also gain

* Dollar extends gains against yen, euro

* Gold extends Wednesday's losses

* Oil higher on kidnapping of Libyan PM

By Ryan Vlastelica

NEW YORK, Oct 10 (Reuters) - Global stock markets and thedollar rallied on Thursday as the first signs of progresstowards ending the budget and debt limit deadlock in Washingtonhelped dial down fears 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-week highagainst most major currencies by the middle of the Europeansession as recent U.S. lending market tensions also relaxed.

"It would be a minor sign of hope there may be some morepositive news coming in the next couple of days, hard to makemuch more out of that," said Fred Dickson, chief marketstrategist, D.A. Davidson & Co in Lake Oswego, Oregon.

"The markets right now are betting somebody will blinkbetween now and October 17."

The Dow Jones industrial average was up 181.65points, or 1.23 percent, at 14,984.63. The Standard & Poor's 500Index was up 22.10 points, or 1.33 percent, at 1,678.50.The Nasdaq Composite Index was up 59.42 points, or 1.62percent, at 3,737.20.

European stocks were strong too, up 1.6 percent andon course for their best day in a month after closing onWednesday at their lowest since Sept. 5.

Treasury Secretary Jack Lew warned the standoff wasstressing financial markets but that prioritizing governmentpayments just to avoid hitting the debt limit would beirresponsible.

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.

The U.S. dollar index rose 0.2 percent against abasket of currencies, and with the dollar heading up, the euro was already on the back foot. Further pressure came afterboth French and Italian industrial production figures fell shortof expectations.

The euro slipped 0.1 percent to $1.3508.

The dollar rallied 0.8 percent to 98.15 yen, up froma two-month low of 96.55 yen hit on Tuesday. Traders said thedollar rebounded after finding strong support at its 200-daymoving average, currently at 96.82.

DEAL OR NO DEAL

The number of Americans filing new claims for unemploymentbenefits hit a six-month high last week, pressured by the U.S.government shutdown.

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 increased as the deadline nears.

The benchmark 10-year U.S. Treasury note wasdown 15/32, with the yield at 2.7163 percent.

There were few signs of nerves on European bond markets,however, with German government bonds, typically favored 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 program was a "closecall" 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 0.6percent, extending Wednesday's 0.9 percent decline.

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

Brent rose 1.3 percent to $110.44 per barrel and U.S. crudeprices added 0.1 percent to about $101.75 a barrel. U.S.prices had tumbled 1.9 percent on Wednesday after the largestweekly build-up of U.S. stocks in a year added to the worries ofa market already concerned about the budget deadlock.

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