LONDON -- Markets remained under pressure Friday ahead of the start of budget discussions between President Barack Obama and congressional leaders and as investors fretted over a military escalation in Gaza.
Japanese stocks, however, enjoyed solid gains on hopes that elections next month may lead to more stimulus measures being enacted, in the latest attempt to get the stuttering economy moving.
Over the past couple of weeks, a combination of factors has turned sentiment in the markets sour. As well as ongoing worries over Europe's debt crisis, investors have grown worried about the state of the U.S. public finances and rising tensions in the Middle East as Israeli troops massed near Gaza -- a possible signal that a ground invasion might be imminent.
In Washington, Obama and the Republican-controlled House of Representatives have to thrash out a budget deal soon to avoid the so-called `fiscal cliff' at the start of next year -- a series of automatic tax rises and spending cuts that will come into force if an agreement is not reached. Some economists estimate that could cut around 5 percentage points off U.S. growth, plunging the world's largest economy into recession and seriously derailing the global economy.
"Investors will be hoping that there is enough collective desire to reach agreement, but it is almost inevitable that discussions will be protracted and go down to the wire, which is likely to keep markets erratic and volatile over the coming week," said Rebecca O'Keeffe, head of investment at Interactive Investor.
"Investors will also be hoping that the focus of attention is not diverted by events in the Middle East," she added.
In Europe, the FTSE 100 index of leading British shares was down 0.6 percent at 5,642 while Germany's DAX fell 0.5 percent to 7,006. The CAC-40 in France was 0.4 percent lower at 3,370.
Wall Street was poised for a weak opening too, with Dow futures and the broader S&P 500 futures 0.4 percent lower.
In the risk-averse trading environment, the dollar garnered some support through its supposed status as a safe haven financial asset. The euro was 0.4 percent lower at $1.2736.
Trading in Asia was similarly subdued. Hong Kong's Hang Seng rose 0.2 percent to 21,159.01 but South Korea's Kospi fell 0.5 percent to 1,860.83.
Benchmarks in China fell, with the Shanghai Composite Index closing 0.8 percent lower at 2,014.72 while the Shenzhen Composite Index fell 0.7 percent to 800.20.
Japan's Nikkei 225 stock index jumped 2.2 percent to close at 9,024.16, rallying for a second straight day on expectations that the opposition Liberal Democratic Party may win elections next month and pursue more aggressive stimulus policies than the current leadership. Prime Minister Yoshihiko Noda dissolved the lower house of parliament Friday, paving the way for elections in which his ruling party will likely give way to a coalition government.
"Equity markets in Japan have taken heart from the decision to call a snap election, with the LDP opposition promising more aggressive support for the economy," said Interactive Investor's O'Keeffe.
Japan's exporters, whose fortunes are linked to the yen's valuation, were buoyed by the prospect of a changing of the guard. Mazda Motor Corp. soared 7.1 percent. Nissan Motor Co. jumped 5.1 percent. Nikon Corp. surged 7.2 percent and Canon Inc. gained 5.8 percent.
The yen has also recovered its poise after two days of selling, with the dollar down 0.2 percent at 81.10 yen.
Oil prices tracked equities lower with the benchmark New York rate down 29 cents at $85.16 a barrel.