(Corrects date of week in first paragraph)
* Stocks, dollar rise as gold hits lowest since July 10
* Expectations grow for deal to lift U.S. debt ceiling
* Silver slides more than 3 pct to two-month low
By Jan Harvey
LONDON, Oct 15 (Reuters) - Gold prices steadied on Tuesday as an early drop to three-month lows tempted some buyers back to the market, but stayed under pressure as hopes that policymakers are close to resolving U.S. debt negotiations in Washington lifted stocks and the dollar.
The dollar index hit a one-month peak, European shares rose for a fourth session in a row and U.S. stocks pared early losses on signs that a deal could soon be reached in Washington to avert a damaging debt default.
Spot gold plunged to its lowest since July 10 at $1,251.66 in early trade, but had recovered to $1,271.21 by 1423 GMT, down 0.1 percent. U.S. gold futures for December delivery were down $5.20 at $1,271.40.
"Nerves are fraying, and that's being reflected in huge moves in the gold market as sentiment ebbs and flows," Societe Generale analyst Robin Bhar said. "The default move is that we will get an agreement, and that will send gold even lower. That's just another reason to lighten up on gold."
Silver was down 0.4 percent at $21.17 an ounce, having earlier touched a low of $20.48 an ounce, its weakest since August 9.
U.S. Senate Majority Leader Harry Reid, a Democrat, said that he and Republican counterpart Mitch McConnell had made "tremendous progress" in talks on Monday and suggested that a deal could come later on Tuesday.
Republican lawmakers and aides said on Tuesday that Republicans in the House of Representatives hope to pass their own version of legislation to reopen the federal government that would differ from a plan now emerging from Senate negotiations.
Gold has fallen 25 percent this year on expectations the Federal Reserve will soon wind down its monetary stimulus programme, which has lifted gold by keeping pressure on long-term interest rates and stoking inflation expectations.
The precious metal is now on track for its first annual price fall since 2001.
Investors continued to liquidate bullion, with holdings of the world's largest gold-backed exchange-traded fund, New York's SPDR Gold Trust, falling another 1.8 tonnes on Monday to 4-1/2 year lows.
The trust reported its biggest weekly outflow in three months last week, losing slightly more than 9 tonnes.
"Investors are becoming increasingly worried about gold's long-term stance as an investment product, whilst U.S. equities continue to remain near all-time highs," MKS Capital said in a note.
In Asia, a key centre for physical gold demand, prices held in a narrow range overnight, with a number of markets closed for holidays, including Singapore and Indonesia.
Spot platinum was down 1.1 percent at $1,361.99 an ounce, while spot palladium fell 1.2 percent to $703.72 an ounce. (Editing by William Hardy)