Deadlock over U.S. debt continues to weigh on dollar

The deadlock over raising the U.S. debt ceiling continued to weigh on stocks and the dollar Tuesday after President Barack Obama warned that his country was dangerously close to a default.

The United States has until Aug. 2 — now just a week away — to reach a deal to increase its $14.3 trillion debt limit or face not being able to pay its bills. That has led to fears the world's largest economy could default on its financial obligations and send shockwaves throughout world markets.

Both Democrat Obama and the Speaker of the House of Representatives, Republican John Boehner, spoke to Americans on Monday. Obama said a compromise was needed to avoid a "reckless and irresponsible" outcome. Boehner appeared to dig in his heels, saying Obama would not get what he seeks.

Democrats are seeking a combination of spending cuts and revenue increases to solve the debt crisis, while Republicans have vowed that any compromise must not include higher taxes.

Though most investors think a last-minute deal to raise the debt limit will eventually emerge, the difficulty of reaching an agreement may leave a lasting impact on investor sentiment. A big worry in the markets is that only a short-term deal will be agreed, with a promise to revisit the issue later. The problem is that next year is election year.

"It's hard to see anything more significant right now than U.S. lawmakers ensuring they don't navigate the global economy into a very dark pit," said Ben Critchley, sales trader at IG Index.

In Europe, the FTSE 100 index of leading British shares was down 0.3 percent at 5,909 while Germany's DAX fell 0.3 percent to 7,320. The CAC-40 in France was 1.1 percent lower at 3,772.

In the U.S., the Dow Jones industrial average was down 0.7 percent at 12,508 while the broader Standard & Poor's 500 index fell 0.5 percent to 1,331.

Soft earnings from Deutsche Bank, BP and UBS as well as meager growth figures in Britain further on sentiment in Europe. A 1 percent fall in new home sales in the U.S. in June reminded investors that the U.S. housing market, which was behind 2008's banking crisis and the subsequent recession, remains weak.

Some positive news emerged in a monthly gauge of U.S. consumer confidence. The Conference Board's monthly index surprisingly spiked 1.9 points in July to 59.5. That followed two straight monthly declines.

However, analysts warned that a solution to the U.S. debt ceiling will be required if consumers, so important for the U.S. economy, are to grow more confident in the months ahead.

"Resolving the most pressing issue right now, raising the U.S. debt ceiling and coming up with a credible plan, will go a long way to boosting still-beaten up consumer confidence and business spending and hiring intentions," said Jennifer Lee, senior economist at BMO Capital Markets.

The dollar has also drifted downward as the debt negotiations have dragged on. By mid afternoon London time, the euro was 0.7 percent higher at $1.4469, near its highest level since July 5.

Worries over the U.S. debt debate have eclipsed those in Europe after last week's rescue package for Greece reined in fears that the country would suffer what is known as a disorderly default on its debts.

The main European debt worry is now whether larger countries like Italy and Spain will get sucked into the mire. Bond markets are a bit calmer Tuesday, a day after contagion fears reemerged. Borrowing costs for both Italy and Spain have held steady after ratcheting higher Monday.

Earlier in Asia, stocks bucked the selling trend, with Japan's Nikkei 225 stock average closing 0.5 percent higher at 10,097.72. Hong Kong's Hang Seng Index gained 1.3 percent to 22,572.08 and South Korea's Kospi added 0.9 percent to 2,168.70.

China's Shanghai Composite Index advanced 0.5 percent to 2,703.03. The index fell 3 percent Monday following a weekend high-speed train crash that killed at least 39 people.

Oil prices declined in line with stocks, with the front-month New York contract trading $1.20 lower at $98.05 a barrel.