* 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 the dollar rallied on Thursday as the first signs of progress towards ending the budget and debt limit deadlock in Washington helped dial down fears of a calamitous U.S. default.
House Republican leaders will visit the White House later as efforts intensify to break the impasse that has left parts of the U.S. government shuttered for more than a week.
The dollar strengthened and was near a three-week high against most major currencies by the middle of the European session as recent U.S. lending market tensions also relaxed.
"It would be a minor sign of hope there may be some more positive news coming in the next couple of days, hard to make much more out of that," said Fred Dickson, chief market strategist, D.A. Davidson & Co in Lake Oswego, Oregon.
"The markets right now are betting somebody will blink between now and October 17."
The Dow Jones industrial average was up 181.65 points, or 1.23 percent, at 14,984.63. The Standard & Poor's 500 Index was up 22.10 points, or 1.33 percent, at 1,678.50. The Nasdaq Composite Index was up 59.42 points, or 1.62 percent, at 3,737.20.
European stocks were strong too, up 1.6 percent and on course for their best day in a month after closing on Wednesday at their lowest since Sept. 5.
Treasury Secretary Jack Lew warned the standoff was stressing financial markets but that prioritizing government payments just to avoid hitting the debt limit would be irresponsible.
Both U.S. political parties floated the possibility on Wednesday of a short-term increase in the country's $16.7 trillion debt limit to avoid a default and allow time for broader negotiations.
The U.S. dollar index rose 0.2 percent against a basket of currencies, and with the dollar heading up, the euro was already on the back foot. Further pressure came after both French and Italian industrial production figures fell short of expectations.
The euro slipped 0.1 percent to $1.3508.
The dollar rallied 0.8 percent to 98.15 yen, up from a two-month low of 96.55 yen hit on Tuesday. Traders said the dollar rebounded after finding strong support at its 200-day moving average, currently at 96.82.
DEAL OR NO DEAL
The number of Americans filing new claims for unemployment benefits 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 shares elsewhere lost ground.
Investors have expected the Republicans and Democrats to cut a deal by an Oct. 17 deadline to raise the debt ceiling, though each day that passes without an agreement tests their nerves.
It is unclear how long a short-term deal would be effective for, but any move to raise the borrowing limit would at least stave 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 equity strategist at Japan's Nissay Asset Management. "Investors are cautiously buying back."
Strains in short-term U.S. interest rates and funding markets have increased as the deadline nears.
The benchmark 10-year U.S. Treasury note was down 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 by risk-sensitive investors, edging lower and higher-yielding euro zone periphery debt faring better.
News that the Federal Reserve's decision last month not to reduce its $85 billion-a-month bond-buying program was a "close call" helped buoy the U.S. currency.
"This is consistent with our expectations that the Fed will taper purchases at the upcoming December meeting," Barclays Capital said in a note. "That said, the ongoing federal government shutdown and upcoming expiration of the debt ceiling suggests that the decision to taper could be pushed into 2014."
As the dollar regained its footing, gold eased 0.6 percent, extending Wednesday's 0.9 percent decline.
Oil rose on news Libya's prime minister had been seized by armed gunmen in a Tripoli hotel, although he was later freed.
Brent rose 1.3 percent to $110.44 per barrel and U.S. crude prices added 0.1 percent to about $101.75 a barrel. U.S. prices had tumbled 1.9 percent on Wednesday after the largest weekly build-up of U.S. stocks in a year added to the worries of a market already concerned about the budget deadlock.