* World shares gain 0.7 pct on hopes for U.S. budget talks
* European shares rise over 1 pct, U.S. stocks set to open higher
* Oil nears $110 a barrel as Middle East tension adds support
* Dollar touches a 7-month high vs yen
LONDON, Nov 19 (Reuters) - World share markets and commodities rose on Monday, recovering some of their sharp losses last week, on signs of progress in talks to resolve the fiscal crunch in the United States.
Gains in U.S. stock futures pointed to a firmer start on Wall Street as well, extending a rally that began on Friday.
The optimism was fuelled by comments from U.S. lawmakers who indicated that compromises are possible in negotiations to avert $600 billion in tax increases and spending cuts due to start in January - the "fiscal cliff" that threatens to send the economy back into recession.
MSCI's world equity index jumped 0.7 percent to 398.50 points, recovering part of last week's 2.7 percent fall, its biggest five-day drop since early June.
"The thing about markets is if they can see there's light at the end of the tunnel, then they're going to discount that," said Mike Ingam, market analyst at BGC Partners. "At the moment...there is very little clarity as to what the end game actually is although, of course, everybody expects there to be a compromise."
There was also optimism in Europe over the prospects of a deal this week to release much-needed aid for Greece.
European officials are expected to discuss a two-year funding plan for Athens at a meeting on Tuesday, which would postpone any longer-term solution until after a September 2013 German general election.
European Central Bank policymaker Joerg Asmussen said at the weekend that the ministers were likely to agree the deal and leave resolution of a longer-term debt stabilisation plan for Greece, at the heart of a disagreement with the IMF, until later.
The euro rose 0.25 percent to a high of $1.2775, well above the two-month low of $1.2661 hit last week and near the top end of its recent range, suggesting the foreign exchange market expects an agreement on Greece.
"This message from the ECB would tell me that, yes, what we are heading to this week is an agreement that would keep Greece out of trouble for the next year or so," said Gilles Moec, senior European economist at Deutsche Bank.
European share markets also enjoyed a strong rebound from the lows of last week, mainly on the growing optimism over the U.S. political negotiations.
The FTSE Eurofirst 300 index of top European shares was up 1.3 percent at 1,076.03 points, led by sectors that depend on economic growth, such as auto stocks, basic resources and banks.
In the region's main centres London's FTSE 100, was up 1.3 percent, while Frankfurt's DAX and Paris's CAC-40 rose by over 1.6 percent.
Safe haven bond markets reflected the stronger risk appetite with the 10-year U.S. Treasury yield edging up to around 1.61 percent, still only about 22 basis points above a record low set in late July.
The 10-year German government bond yield moved up to 1.35 percent but traders said there was room for yields to rise much further if euro zone policymakers reached an agreement at their meeting on Tuesday.
In the currency markets the dollar briefly extended its gains against the yen on expectations a new Japanese government will push the central bank into taking aggressive monetary stimulus measures to boost growth after next month's elections.
The greenback rose to 81.59 yen, its highest level since April 25, before steadying to be around 81.28 yen.
The Bank of Japan began a two-day meeting on Monday, but is not expected to take any new policy steps before the Dec. 16 vote.
The rising hopes of a deal on closing the U.S. budget gap, which had clouded the outlook for global growth, spread through the commodity markets lifting oil, copper and gold.
Copper rallied more than 1 percent to $7,696.25 a tonne on the London Metal Exchange, and gold was up 0.6 percent at $1,723.6 an ounce.
A drop in the dollar index which had eased from a two-month high hit on Friday, added to demand by making commodities priced in the greenback more affordable for buyers holding other currencies.
In oil markets, Brent crude rose to almost $110 a barrel as the escalating violence between Israel and the Palestinians fuelled concern about supplies from the Middle East.
Investors fear the conflict may draw in other countries and possibly disrupt energy exports from the region, which supplies more than a third of the world's crude.
Brent crude for January delivery was up 92 cents to $109.87 a barrel and U.S. crude futures gained $1.00 to $87.92 a barrel.