GLOBAL MARKETS-Europe sags on Italy concerns, lending weakness
* European shares, euro falls on weak data, Italy tensions
* Investors distracted by U.S. budget wrangling
* Wall Street hoping for first gains in 5 sessions
* Japanese stocks bounce as yen falls into quarter end
* Oil slips towards $108 on Iran progress hopes
By Marc Jones
LONDON, Sept 26 (Reuters) - Fresh signs of euro zone economic fragility and rising political pressure in Italy hit the euro and the region's shares on Thursday, adding to wider market worries about a potential U.S. government shutdown.
Wall Street was expected to open with gains of 0.2-0.3 percent as both the S&P 500 and Dow Jones Industrial look to snap a five-day run of losses.
Focus is set to remain on Washington's budget wrangling but investors already have a flurry of data to digest which included some upbeat jobless claims numbers that helped lift the dollar and offset some of the reemerging European concerns.
Data from the European Central Bank earlier showed that lending to companies fell in all of the euro zone's big countries in August, highlighting the questionable strength of the currency bloc's economic recovery.
Attention was also back on Italy as allies of scandal-hit former Prime Minster Silvio Berlusconi renewed threats to bring down the coalition government if he is barred from politics as part of his punishment for tax fraud.
Italian shares were down 1.5 percent ahead of the U.S. restart leading a sea of red on European stock markets and the euro was having its weakest day against the dollar in three weeks as it fell below $1.35.
Italian government bonds were the region's worst performer too as yields - which move inversely to prices - climbed 10 basis points.
"This is the latest in a series of politically noisy events that threatens not only the stability of the current government, but the longer-term reform process more generally," Timo del Carpio, European economist at RBC Capital Markets, said.
In addition to the falls in Milan, Germany's DAX and France's CAC 40 dropped 0.1 percent although both trimmed losses after the U.S. data, while London's FTSE turned positive.
BANGING ON THE CEILING
With the outlook for U.S. monetary policy up in the air, dealers were reluctantly conceding attention to the budgetary antics going on in Washington.
Congress is currently struggling to pass a spending bill to keep the government funded beyond Oct. 1, but that is just a taster for the fight over raising the debt limit.
U.S. Treasury Secretary Jack Lew warned that the United States would exhaust its borrowing capacity no later than Oct. 17, though analysts reckon it could keep paying its debts to at least the end of the month.
"Between now and Monday evening, we expect Congress to pass a continuing resolution (CR) that funds the government to at least Nov. 15, if not longer," Deutsche Bank economists wrote in a client note.
"If a CR is passed in time, or if the government closes for only a day or so, the probability of a debt ceiling impasse is reduced. Critically, under no circumstance do we expect the Treasury to default on its obligations."
In the past, the U.S. dollar and stocks have tended to weaken before such political showdowns, only to rally once the issue was resolved.
So far markets are following the script with the Dow Jones industrial average and the S&P 500 index both down for the past five sessions, the first time the benchmark S&P 500 has seen such a poor run this year.
U.S. Treasuries rallied for the fourth straight session as investors took a "just in case" attitude.
Yields on the benchmark 10-year note were hovering at 2.624 percent, making a fall of roughly 25 basis points since last week's shock decision by the Federal Reserve to maintain its asset buying programme for now.
That decline has in turn shrunk the yield premium Treasuries pay over 10-year German debt though the euro zone rumblings on Thursday expanded the gap again as Bund yields hit a six-week low of 1.758 percent.
In commodity markets, oil prices were pressured by hints of progress between the U.S. and Iran.
Brent crude for November delivery fell as low as $108 before a rebound lifted it back to $109, and U.S. crude edged up to $103.15 a barrel.
Copper futures were up 1 percent to $7,270 per tonne, while gold edged up a few bucks to $1,336.90 an ounce.
Japan's Nikkei was one of the few big risers among the major stock markets. It ended the day 1.2 percent higher after Kyodo News reported the government would consider cutting corporate taxes, a proposal that has swung in and out of favour for weeks now.
The bounce in Japanese shares in turn weighed on the yen, already pressured by Japanese selling for month and quarter-end. The dollar popped as high as 99.00 yen, from an early 98.46 and it was last trading at 98.84 yen.
Measured against a basket of currencies, the dollar eked out a marginal gain and it was up on the euro at $1.3500 .
Elsewhere in Asia MSCI's broadest index of Asia-Pacific shares outside Japan finished flat on the day. Shanghai stocks shed 1.2 percent and Singapore lost 0.3 percent.
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