GLOBAL MARKETS-Japan shares rally, caution the watchword elsewhere
* Japanese stocks bounce as yen falls into quarter end
* Other markets subdued, investors distracted by US budget wrangling
* European shares seen starting modestly lower
SYDNEY, Sept 26 (Reuters) - Asian share markets were left in limbo on Thursday as investors sweated out the latest battle over the U.S. budget, though Tokyo rallied as talk of a corporate tax cut resurfaced.
After a weak start, Japan's Nikkei erased all its losses to be up 1 percent 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 shares in turn weighed on the yen, already pressured by Japanese selling for month and quarter-end. The dollar popped up to 98.92 yen, from an early 98.46, while the euro gained almost a full yen to 133.80.
Measured against a basket of currencies, the dollar eked out a marginal gain and it was barely changed on the euro at $1.3522.
Elsewhere caution was the watchword, with MSCI's broadest index of Asia-Pacific shares outside Japan flat on the day so far. Shanghai stocks shed 1.2 percent and Singapore lost 0.3 percent.
Europe seemed similarly circumspect as spreadbetters had Britain's FTSE 100, Germany's DAX and France's CAC 40 opening 0.1 to 0.2 percent lower.
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 November 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 ahead of such political showdowns, only to rally once the issue was resolved.
So far markets are following the script with the Dow Jones industrial average down 0.4 percent on Wednesday, while the S&P 500 Index faded 0.27 percent. It was the fifth consecutive session of losses for the benchmark S&P 500, the first such period for 2013.
In counterpoint to the softness in stocks, 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 2.64 percent on Thursday, making a fall of 21 basis points since last week's shock decision by the Federal Reserve to maintain its asset buying program.
That decline has in turn shrunk the yield premium Treasuries pay over 10-year German debt by 10 basis points to 82 basis.
In commodity markets, oil prices were pressured by hints of progress between the U.S. and Iran.
Iranian President Hassan Rouhani said in a newspaper interview on Wednesday that he wants to reach a deal with world powers on Tehran's nuclear program in three to six months.
Brent crude for November delivery fell 11 cents to $108.21, while November U.S. crude lost 19 cents to $102.47 a barrel.
Copper futures were off 0.1 percent to $7,189.00 per tonne, while gold eased a couple of bucks to $1,330.51 an ounce.