By Richard Hubbard
LONDON (Reuters) - Cautious optimism that the U.S. government would avert an economically damaging debt default lifted world shares and supported the dollar on Tuesday though prices traded within tight ranges.
The hopes for a deal rose after U.S. Senate Majority Leader Harry Reid, a Democrat, and his Republican counterpart, Mitch McConnell, ended a day of talks on Monday, with Reid saying they had made "tremendous progress".
While markets remain wary over the eventual outcome, the signs of a last minute deal lifted Europe's blue chip index, the Euro STOXX 50, by 0.4 percent to reach a 2-1/2-year high. Germany's DAX touched a record peak.
"Optimism that a deal will soon be agreed continues to prevail. Relief that politicians have taken the U.S. to the edge and back again is clear," said Keith Bowman, equity analyst at Hargreaves Lansdown.
Earlier, the more bullish sentiment had boosted Asian shares to their highest in nearly five months and seen Japan's Nikkei gain 0.25 percent to be near a two-week peak.
The gains around the world have lifted MSCI's world equity index, which tracks share in 45 countries, by 0.2 percent, leaving it just three points below a five-year high hit in mid-September before the crisis in Washington began.
DOLLAR FIRM
The dollar meanwhile was holding firm against most major currencies, having suffered the most from fears that the political dysfunction in Washington could leave the U.S. struggling to service its massive debts.
Any gains in the dollar are seen as limited as the government shutdown forced by the political impasse is expected to have hurt the U.S. economic recovery and convinced many that the Federal Reserve will have to extend its monetary stimulus.
"If we get some kind of temporary resolution in the U.S. it will still have a small positive short-term impact on the dollar. But in the medium term this is clearly dollar negative," said Richard Falkenhall, currency strategist at SEB.
The greenback reached a peak of 98.71 yen, before giving up gains to trade at 98.47 yen, down 0.1 percent. Against a basket of currencies, the dollar stood at 80.29, some distance above the eight-month low of 79.63 hit earlier this month when the government began a partial shutdown.
The euro was little changed at $1.3557, well within a recent trading band of $1.35 to $1.36.
Elsewhere in the currency market, the Australian dollar jumped to a four-month high when minutes of the central bank's October 1 meeting revealed it was prepared to cut interest rates further though it was in no hurry to act.
EUROPE RECOVERY
Aside from the U.S. budget negotiations, European traders were looking ahead to the release of Germany's ZEW sentiment survey which is expected to stay high as evidence mounts of a fragile recovery spreading across the euro area.
Separate data on price pressures in Britain are forecast to show inflation to have eased slightly although it remains well above the Bank of England's two percent target.
German 10-year government bond yield were at their highest levels in three weeks, up 3.5 basis points at 1.9 percent, ahead of the ZEW data thanks to the easing of tension over the prospect of the U.S. debt default.
Gold, whose safe-haven appeal is usually burnished during times of uncertainty, was steady but near 3-month lows having lost about 4 percent in value to be below $1,300 an ounce since a partial government shutdown began on October 1.
It traded down 0.1 percent at $1,271.50 an ounce.
In addition to the U.S. budget negotiations, oil traders were keeping an eye on talks in Geneva over Iran's nuclear programme that might eventually lead to a pick-up in its oil shipments.
On Monday the United States held out the prospect of quick relief from sanctions for Iran if Tehran moved swiftly to allay concerns about its programme though any deal on this issue . could take some time.
Brent crude futures were trading 10 cents up at $111.15 a barrel at 0745 GMT, after ending lower in the two previous sessions. (Additional reporting by Atul Prakash and Jessica Mortimer; editing by Stephen Nisbet)
