GLOBAL MARKETS-Dollar pressured by US politics, stocks flatline
* Dollar on defensive as US government stays shut, debt ceiling looms
* Obama meets congressional leaders, but makes no progress
* Stocks unsettled while bonds gain amid risk aversion
SYDNEY, Oct 3 (Reuters) - The U.S. dollar stayed under pressure on Thursday while share markets flatlined as the U.S. government shutdown dragged on with no obvious end in sight, stirring unease about the country's economy and its debt ceiling.
With investors choosing discretion as the better part of valour, MSCI's broadest index of Asia-Pacific shares outside Japan was barely changed, after a flat performance on Wednesday.
Japan's Nikkei slipped 0.5 percent, while Australian shares added 0.2 percent.
A meeting between President Barack Obama and congressional leaders produced nothing but blame and counter-blame, dimming hopes of an early end to the impasse.
So far investors have been wagering that a deal would be reached in time to avoid lasting damage to the economy, although another fight over the debt ceiling still looms.
The ceiling is far more important than the shutdown since it could lead to an unprecedented default by the United States, an outcome the market assumes is unthinkable.
"To the extent that we have never been in a situation where the debt ceiling has not been raised, there is a high degree of uncertainty over how events will transpire," said Elliot Clarke, an economist at Westpac.
"That said, what is plainly evident is that a protracted stalemate would have a significant impact on the US economy."
Already one effect has been to further cloud the outlook for when the Federal Reserve might start scaling back its asset buying program.
Fed Bank of Boston, Eric Rosengren, said the government shutdown could further delay a tapering because of a lack of official data on the economy.
That only amplified the swing in market expectations on the future course of U.S. interest rates, which has been dramatic.
Just a month ago the futures market had predicted the Fed funds rate would be up around 1.465 percent by the end of 2015. Now it implies a rate of just 0.745 percent.
That in turn has helped drag yields on the benchmark 10-year U.S. Treasury note down to 2.617 percent, from a September peak of 2.99 percent.
The dollar's diminishing yield advantage saw it peel off to a five-week low on the yen at 97.27. The euro was up at $1.3584 having gained three quarters of a cent overnight. Likewise, the dollar index touched its lowest since February.
In contrast to the increasingly dovish outlook for U.S. rates, the ECB on Wednesday left interest rates unchanged and gave no hint it was considering further easing.
Also aiding sentiment on European assets was a victory for Italian Prime Minister Enrico Letta's government in a no confidence vote, which ended fears that the euro zone's third-largest economy would be forced into new elections.
Italian shares and bonds both rose as it become clear that former Prime Minister Silvio Berlusconi would drop his attempts to bring down the government, sending Milan's FTSE MIB share index up as much as 1.8 percent.
Otherwise, global shares ended Wednesday with only modest losses. The Dow Jones industrial average eased 0.39 percent, while the S&P 500 was a fraction lower. MSCI's world equity index dipped 0.13 percent.
In commodity markets, trading was very choppy though the lower dollar did tend to support prices. Gold had rebounded to $1,312.66 an ounce, so recouping most of Tuesday's sharp fall. Copper futures pared their gains to stand at $7,268.25 a tonne.
Oil prices edged off after a jump on Wednesday. Brent crude for November eased 28 cents to $108.91 a barrel, while U.S. crude dipped 44 cents to $103.67.