* Shift in Fed tapering talk raises volatility fears
* Weak euro zone factory data adds to pressure on shares
* Dollar hovers near two-week lows against a currency basket
* Italian debt costs rise as Fed, politics weigh
By Richard Hubbard
LONDON, Sept 12 (Reuters) - A drop in euro zone factory output after a run of weaker-than expected U.S. data stalled an eight-day rise in world shares on Thursday, jangling the nerves of investors positioning for a shift in Fed policy next week.
Moves towards a diplomatic solution on Syria gave some support to financial markets, but doubts over what exactly the Fed will announce on Sept. 18 increase the potential for near-term volatility.
“The Fed is still likely to taper next week or in October but the trajectory of the tapering that we had assumed can no longer be taken for granted,” said Ned Rumpeltin, head of G10 FX strategy at Standard Chartered Bank.
Euro/dollar and dollar/yen one-week implied volatilities - a gauge of how sharp price swings will be next week - have shot up as investors try to guess when and how fast the Fed will start to run down its monetary stimulus.
The one-week euro/dlr implied volatility traded at around 7.85 percent, much higher than the equivalent one-month rate which was around 7.2 percent.
The one-week dollar/yen implied volatility was also trading much higher than the one-month level.
Uncertainty has grown with weaker-than-expected U.S. data, including jobs growth in August and consumer spending, home building, new home sales, durable goods orders and industrial production in July.
A Reuters poll of economists on Monday this week found most now see the Fed trimming its $85 billion monthly spend on bonds by about $10 billion. This was down from $15 billion in a poll before the jobs report.
The shifting views have put pressure on the dollar, which hovered near two-week lows against a basket of major currencies on Thursday. U.S. Treasury yields have dipped to nearer 2.8 percent from over 3 percent last week.
But the euro slipped against the dollar on Thursday and European shares ended a run that had taken them near a five-year high when data showed a surprisingly large drop in industrial output across the currency bloc in July.
That bolsters the case for the European Central Bank to keep monetary policy loose in the face of changes at the Fed and adds weight to the argument that it should even consider another rate cut.
Europe’s broad FTSE Eurofirst 300 index was down 0.1 percent by mid-morning at 1,248.33 points, edging away from a 5-year high of 1,258.09 points reached in late May this year.
The MSCI world equity index was slightly lower, with U.S. stock index futures pointing to further weakness when trading gets underway on Wall St.
Reduced expectations of the degree of Fed tapering eased pressure on emerging market currencies, which had been driven up as the cheap U.S. money was pumped into high-yielding stocks and bonds, and are now falling as these trades reverse.
Indonesia’s central bank unveiled a surprise rate hike to help the rupiah recover from a 4-1/2 year low. Other Asian central banks were expected to wait for next week’s Fed decision before taking any action.
MSCI’s broadest index of Asia-Pacific shares outside Japan shed 0.2 percent while the stronger yen and downbeat economic data helped push Japan’s Nikkei stock average down 0.3 percent.
In fixed income markets anticipation of the Fed trimming its stimulus combined with concerns abut domestic politics drove up Italy’s borrowing costs at an auction of 7.5 billion euros ($10 billion) of new debt.
A cross-party Senate committee in Italy is due to resume a hearing later on whether to bar Silvio Berlusconi from political life, at the risk of prompting the former prime minister’s allies to pull out the coalition government.
No decision by the Senate is expected until mid-October leaving investors in considerable uncertainty over whether the government has the strength to overhaul the economy and manage its budget deficit.
In commodities, copper slipped 0.9 percent to $7,101 a tonne . An improved outlook for China’s economy and the reduced risk of a strike on Syria have helped bring copper prices off the three-year lows plumbed in late June.
Gold skidded 1.8 percent to $1,342.56 an ounce, its weakest since mid-August while Brent crude added about 0.8 percent to $112.40 as investors watched diplomatic efforts to place Syria’s chemical weapons under international control stepped up.
U.S. Secretary of State John Kerry and Russian Foreign Minister Sergei Lavrov were meeting in Geneva on Thursday to try to agree on a strategy to eliminate the chemical arsenal. [ID:nL2N0H71L6}