* Dollar hits 7-1/2 month low against major currencies
* Wall Street opens lower as budget deal looks unlikely
* World shares weaken but set to end quarter with gains
* Italian bond yields off highs as election fears recede
By Richard Hubbard
LONDON, Sept 30 (Reuters) - Concerns about a loomingpolitical showdown in Washington rattled investors on Monday,sending equities and the dollar lower, though moves that couldhelp Italy's government survive saw Italian shares pare losses.
Deadlock in the U.S. Congress has made it increasinglypossible the government will run out of money from midnight,while a split in Italy's ruling coalition had heightened fears of fresh elections that could delay key economic reforms.
U.S. stocks opened lower, with investors fearful a prolongedgovernment shutdown could have significant implications foreconomic growth and consumer confidence.
The dollar was down 0.6 percent against a basket of majorcurrencies at a 7-1/2 trough. It was close to a 1-1/2year low against the Swiss franc and a one month lowagainst the Japanese yen - both currencies investors tendto see as a safe haven for their money in times of financialuncertainty.
Conversely U.S. Treasuries benefited from a view that theeconomic damage from a government shutdown would be yet anotherreason for the Federal Reserve to delay scaling back itsmonetary stimulus.
"It looks like we're heading toward a shutdown but itsprobably going to be a relatively brief thing," said Phil Tyson,interest rates strategist at brokers ICAP.
Tyson said a bigger risk lay in the upcoming debate over theU.S. government's debt ceiling, which has the potential to causea default that would rock world financial markets.
Adding to market worries was a surprise downward revision toactivity in China's factory sector for September, suggestingAsia's economic powerhouse is still struggling to gain tractionafter a period of slower growth.
Combined with month-end and quarter-end caution among biginvestors, the end result was a shift out of equities and oil.MSCI's world equity index was down 0.5 percentand Brent oil fell to less than $108 a barrel.
MSCI's global index, which tracks shares in 45 countries,remains on course for its best quarter since March 2012 and itsbest month since January as the loose monetary policies of majorcentral banks and signs of modest global economic recoveryfavour equities over alternative investments.
In Europe, Italian government bond yields came off theirhighs after Reuters reported that as many as 20 senators fromthe centre-right party of Silvio Berlusconi were ready to form abreakaway group if he continues to threaten to bring downItaly's government.
The crisis had escalated over the weekend when the formerpremier pulled his ministers out of the frail ruling coalitionand called for new elections, just seven months after the last,inconclusive vote.
Benchmark 10-year Italian debt yields at one point were upas much as 31 basis points to 4.73 percent on the potential forpolitical paralysis before easing back to be up 16 bpts at 4.61percent after the report.
The selloff in Italy only had a muted impact on otherriskier euro zone government bonds with investors drawingcomfort from the improving outlook for the region and an ongoingpromise of support from the European Central Bank.
The political instability left Milan's blue-chip FTSE MIBindex down 1.6 percent, though it too was off its lows.The broad FTSEurofirst 300 index was down nearly onepercent with bank shares taking the brunt of the selling.
The worries saw the euro touch a five month low against the Swiss franc at 1.2218 and it was down 0.8 percent onthe yen at 131.78 yen, having earlier fallen to a three-week lowof 131.385 yen.
The possibility of a U.S. government shutdown did supportgold, which is another refuge for investors in time ofuncertainty, leaving the precious metal headed for its bestquarterly performance in a year.
Spot gold as trading at $1,335.99 an ounce, buildingon 1 percent gain on Friday.
Copper also edged up, extending gains it has made on thebrighter global economic outlook and adding 0.3 percent to tradeat $7,322 a tonne.
"There is obviously a negative economic impact of anyshutdown which could weigh on copper. But if a shutdown doesoccur there is less chance that the Fed will reduce stimulusthis year," said analyst Tim Radford at Sydney-based advisoryRivkin.
- Politics & Government
- government shutdown