By Marc Jones
LONDON (Reuters) - Signs of compromise in U.S. talks to stop automatic tax hikes and spending cuts hurting the economy next year pushed world shares towards a three-month high on Tuesday and weakened appetite for safe-haven bonds and the dollar.
The political divide narrowed on Monday night when President Barack Obama proposed leaving lower tax rates in place for those earning under $400,000, moving closer to the $1 million threshold favoured by Republican House of Representatives Speaker John Boehner.
European shares were up 0.3 percent and closing in on 2012 highs ahead of the Wall Street open. The S&P 500, Dow Jones industrial average and Nasdaq 100 were also expected to rise.
The rally pushed the MSCI index of global stocks up 0.2 percent to the brink of a three-month high, with an 18-month peak also in sight.
"It is reassuring that we are now seeing some signs of compromise in the U.S.," said Daiwa Securities economist Tobias Blattner. "A deal is key to avoiding a major global recession; if we were to fall over the cliff, there would be massive fiscal tightening."
The dollar, a traditional safe-haven currency, fell to a two-month low against a basket of currencies, as the broader market appetite for risk strengthened.
Oil and copper, two commodities closely attuned to global growth expectations both gained, although profit taking saw the latter edge back to $8,026 per tonne as the European session tailed off.
"One would assume that this (fiscal cliff deal progress) would be a positive for commodities," said Stephen Briggs, metals strategist at BNP Paribas in London. "But because base metals have been faring pretty well in the last few weeks, there may be less mileage for them."
Expectations of more monetary easing in Japan following Sunday's return to power of the LDP and its pro-stimulus leader Shinzo Abe added to the optimism and provided additional support for the Nikkei which hit an 8-1/2 month high.
It also kept the yen near a 20-month low versus the dollar. By 1300 GMT the dollar was worth 83.90 yen, up almost 7 percent compared to when it started rising in early November.
"We are in a situation where we will see the government tell the central bank what to do. Such a politicised situation is never good for a currency, and the yen will weaken," said Peter Kinsella, currency strategist at Commerzbank.
With the European Central Bank looking increasingly unlikely to cut interest rates in the next couple of months, the euro remained near Monday's seven-month high at $1.3175.
Newly installed ECB board member Yves Mersch said he saw no logic in cutting rates at the moment.
Data from the UK showed inflation stayed at its highest level since May, confounding forecasts it would ease and potentially giving the Bank of England less room to resume its quantitative easing to support the struggling economy.
However, Sweden cut its interest rates back to 1 percent, Turkey cut rates for the first time in more than a year, while India's central bank reiterated its guidance of further easing in the first quarter of 2013.
In bond markets, trading remained subdued ahead of the year-end. U.S and German government bonds futures slipped as increasing signs of progress in the U.S. budget talks eased demand for low-risk assets.
Concerns that new fiscal stimulus could seriously increase the country's debt burden pushed the benchmark 10-year Japanese government bond yield to a one-month high of 0.750 percent.
With the thin trade accentuating moves, Spanish debt extended gains after its final bill sale of the year raised more than the target amount.
Spanish 10-year bond yields fell 7.5 basis points to 5.38 percent while the equivalent Italian debt fell 8 bps to 4.49 percent, back to where it was before Prime Minister Mario Monti sparked a wave of selling earlier this month by announcing he would resign early.
(Additional reporting by Anirban Nag and William James; editing by Anna Willard and Will Waterman)