By Marc Jones
LONDON (Reuters) - World shares sagged and the dollar climbed on Friday as U.S. lawmakers prepared to resume talks to avoid a fiscal crunch, while expectations Japan will inject drastic new stimulus into its economy pushed the yen to a two-year low.
President Barack Obama and lawmakers are set to have a last round of talks before a New Year's deadline to reach a deal and avoid massive tax hikes and spending cuts which could drag the economy, and others around the world, into recession.
Obama and Vice President Joe Biden will meet congressional leaders from both parties at the White House at 2000 GMT.
As midday approached in Europe, the MSCI all-world share index had lost the momentum of an earlier rally in Asian shares to stand almost unchanged at 338.83.
With London's FTSE 100, Paris's CAC-40 and Frankfurt's DAX also flagging after a positive start, the pan-European FTSEurofirst 300 fell back into negative territory and on track for a small weekly loss.
Members of Congress and economists were divided on the odds of success at the U.S. budget talks but Daiwa Securities economist Emily Nicols said the chances of a deal before year-end were slipping. "Markets in Europe are now down and that is reflecting the U.S situation."
"The Republicans are not coming back until Sunday so it looks increasingly unlikely that a solution will be found before the end of the year, although markets still expect a deal eventually even if it does go into January," she added.
U.S. stock futures pointed to falls on Wall Street when trading resumes later.
Earlier in Asia, Japan's benchmark Nikkei index hit a 21-month high as markets prepared for a huge injection of stimulus by the Bank of Japan following the election of a new government. The expectations also pushed the yen to a new two year low versus the dollar.
Japan's newly appointed Finance Minister Taro Aso said he wants the government and the Bank of Japan to agree on an inflation target in January before the central bank's next policy meeting and stressed a willingness to intervene in FX markets.
"The Japanese equity market has turned positive, providing good sentiment for global investors, with many making money and putting the money into commodity markets such as the oil market," said Tetsu Emori, a commodity fund manager at Astmax in Tokyo.
The dollar rose as high as 86.64 yen. The yen has now fallen roughly 10.5 percent against the dollar in 2012, its biggest annual drop since 2005. At the same time the Nikkei share index is now up 22 percent for the year.
With investors wary about the outcome of the fiscal cliff negotiations, the dollar and German government bonds, both seen as safe-haven assets because of their liquidity, strengthened.
In contrast, with markets starting to focus on uncertain elections at the end of February, Italy's 10-year borrowing costs rose to the highest since October at its first auction for long-term debt to be settled in 2013.
Mirroring equities, the euro gave up early gains to slip back under $1.32. It came as France reported it had managed just 0.1 percent growth in the third quarter.
Despite the tensions over the U.S. budget talks, the mood in financial markets has been improving in recent weeks. Data from key emerging economies have shown signs of a pick-up while analysts are hopeful that Europe may also soon bottom out.
Fresh signs that top consumer China's economy is improving saw growth-attuned copper prices climb as high as $7,955 a tonne, on track for the biggest weekly rise in four weeks.
A new Reuters poll showed economists think China's factory activity probably expanded at its fastest pace in eight months in December.
The U.S. uncertainty weighed on other commodities though. Brent crude was down 0.25 percent just below $111 a barrel by 1100 GMT and on course to post a full-year increase of about 3.6 percent, which would be its smallest gain in four years.
Gold also gave up early gains to drop to $1,658.40 an ounce. However, it looks set to notch its first weekly rise in a month and for the year is up around 6 percent.
"We do expect a ... (U.S. budget) deal to happen at the last minute, but it will be a minimal deal," said Dominic Schnider, an analyst at UBS Wealth Management in Singapore. "I think that should be gold supportive."
(Additional reporting by Lewa Pardomuan; Editing by Giles Elgood)