* Dollar hits 1-mth low to yen on U.S. impasse
* Surprisingly weak private jobs report extends losses
* Short-term U.S. debt default insurance costs rise
* Euro at 8-month high as ECB holds rates, Italian crisis eases
* Oil edges above $108 barrel, gold recovers
By Richard Hubbard
LONDON, Oct 2 (Reuters) - A surprisingly weak U.S. private sector jobs report sapped the dollar and world shares on Wednesday, adding to concerns about the economic impact of the budget standoff in Washington.
Private employers in America added 166,000 new jobs in September, extending a run of modest labour market gains that is seen keeping the Federal Reserve reluctant to scale back its efforts to stimulate the economy.
"If the numbers had come up really, really strong, perhaps people would overlook the problems in Washington. But with the numbers coming in slightly below expectations, it renews concern that the recovery could start to peter out," said Rick Meckler, president of hedge fund LibertyView Capital Management LLC.
Financial markets had been taking a sanguine view of the partial Federal Government shutdown, expecting a resolution before any serious economic impact was felt, with many global stock indexes kicking off the new quarter with gains on Tuesday.
But there is growing concern that the longer the shutdown continues, the bigger its impact and the more likely it is that lawmakers will fail to reach a deal on the more crucial issue of raising the public debt ceiling to prevent a default.
"We do fear that as this discussion drags on, volatility in the market will continue to increase," said Patrick Moonen, senior equity strategist at ING Investment Management.
U.S. stock index futures showed Wall Street was set to open 0.7 percent lower. Global equities, as measured by MSCI's world equity index, were down just 0.15 percent by 1230 GMT having started the new month with a 0.9 percent gain on Tuesday.
The dollar, which had fallen on Tuesday as the shutdown began, fell another 0.5 percent to its lowest since late August against the yen.
The cost of insuring U.S. government bonds against default for the next year also rose, gaining five basis points to raise the cost of protecting $10 million of debt to $35,000 - the highest since Aug. 31 and above the rate for 5-year insurance.
Usually it costs more to buy longer-term default insurance so the current level is considered a classic sign of credit stress, reflecting the concerns over whether the United States will be able to raise the debt limit in coming weeks.
The euro was drawing support from events in Washington and to some extent from the European Central Bank's decision to keep its main refinancing and deposit rates on hold as had been widely expected.
ECB President Mario Draghi, at a subsequent news conference, also kept alive the prospect of further support for the region's economy with looser policies, and said he was keeping a close eye on rising short-term interest rates.
Draghi's lack of concern about the euro exchange rate against the dollar also sent the shared currency to an 8-month high of $1.3590.
A confidence vote for Italian Prime Minister Enrico Letta's government, ending fears that the euro zone's third largest economy would be forced into fresh elections, added to the currency's appeal.
Italian shares and bonds both rose as it become clear former prime minister Silvio Berlusconi would drop his attempts to bring down the government, sending Milan's FTSE MIB share index up as much as 1.8 percent
The main barometer of market concern, the premium investors demand to hold Italian 10-year government bonds over AAA-rated German Bunds, fell to 260 points from 300 basis points at the start of the week as 10-year bond yields eased 10 basis points to 4.37 percent.
In commodity markets, gold edged up from two-month lows below $1,300 an ounce hit when a massive sell order stoked fears of further liquidation. Gold also took some support from the weaker dollar.
Copper futures though dipped 0.4 percent after posting their biggest quarterly gain since March 2012 thanks to a steadier outlook for global growth.
Oil prices recovered from early weakness with the November contract up 29 cents at $108.25 per barrel.