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Markets calm despite looming fiscal cliff

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LONDON (AP) — Markets appeared Monday to be taking in stride the ongoing failure of U.S. politicians to agree a budget deal in time to avoid automatic tax increases and spending cuts that many economists think could tilt the world's largest economy back into recession.

With just hours to go before the U.S. falls off the so-called "fiscal cliff," Republicans and Democrats remained divided over tax and spend, raising the prospect that markets will start 2013 without a clear idea of America's budget policy. The main sticking point appears to be what level of taxes are imposed on higher incomes.

Discussions in the Senate broke off Sunday night without agreement. Senators are due to reconvene at 11 a.m. EST (1600 GMT) try to hammer out a deal before the deadline.

"With precisely zero headway made on the fiscal front resulting from the early weekend return by Congressional lawmakers, hopes are fast-fading of any sort of compromise before the end of 2012," said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co.

However, it's not the first time that budget discussions in the U.S. have gone down to the wire only for a deal to be eventually reached.

Many investors remain confident that some sort of deal will be struck in time following positive noises coming out from late Sunday discussions between Senate Minority Leader Mitch McConnell, a Republican, and Vice President Joe Biden, a Democrat.

Even if a deal is not reached in time, many investors think that the possible damage wrought by the potential $671 billion package of higher taxes and spending cuts will be limited. A backup proposal that would address only a few issues is expected to be presented by Senate Majority Leader Harry Reid, a Democrat, if a bipartisan deal is not reached.

"It is likely that many of the fiscal cliff measures allow a certain amount of room within which the government can introduce measures to refrain from any tax increases," said Joshua Mahony, an analyst at Alpari.

The prospect of counter-measures to offset the "fiscal cliff" impact helps explain why markets were fairly calm in Europe and Asia, and Wall Street was poised to open higher on the last day of a year that's seen many indexes post strong gains, partly through rising hopes over Europe's 3-year debt crisis.

In Europe, the FTSE 100 index of leading British shares closed down 0.5 percent at 5,897.81. For the year as a whole, the FTSE ended 5.8 percent higher.

The CAC-40 in France closed 0.6 percent higher on the day at 3,641.07. In 2012, it rose 15.2 percent.

Those European indexes that were open only traded for half the day. Others, including Germany's DAX, were closed. The DAX was one of the world's best-performers in 2012 with its annual rise of 29.1 percent.

U.S. stocks were poised for gains at the open despite the "fiscal cliff" uncertainty, with both Dow futures and the broader S&P 500 futures up 0.2 percent.

Despite the recent worries, U.S. stocks have had a strong 2012, with the Dow up around 6 percent so far and the S&P 11.5 percent higher.

Developments over the U.S. budget will likely be one of the big issues in financial markets in 2013, especially in the early part, alongside Europe's ongoing efforts to contain its debt crisis and the state of the Chinese economy, now the world's second biggest.

Clearly, the full imposition of the "fiscal cliff" measures would hobble the U.S. economy that has shown some signs of late of a more sustainable economic recovery. Waning U.S. economic growth would have an impact worldwide.

Some economists predict the effects of the "fiscal cliff" could eventually throw the U.S. economy back into recession — although if the deadline passes, politicians still have a few weeks to keep the tax hikes and spending cuts at bay by repealing them retroactively once a deal is reached.

Still, the failure to adhere to the deadline following weeks of squabbling and procrastination could be view negatively by the major credit rating agencies and weigh on investor confidence going into 2013.

"I think the market reaction to that will be very negative. This means the U.S. will never be able to bring its house in order. And the deficit will continue to accumulate," said Francis Lun, managing director of Lyncean Holdings in Hong Kong. "No meaningful reform and no solution in sight. You can throw confidence out of the window."

Earlier in Asia, the picture was fairly subdued in those markets that were open — among others, markets in Japan, were closed for the New Year's holidays. After a stellar performance in December, Japan's Nikkei ended the year almost 23 percent higher.

Hong Kong's Hang Seng, trading for a half-day, closed marginally lower at 22,656.92, to also end the year nearly 23 percent higher.

Mainland Chinese stocks rose Monday after a private survey showed the country's manufacturing growth at its strongest level in 18 months in December. Australia's S&P/ASX 200 fell 0.5 percent to close at 4,648.90.

There was also a fairly calm atmosphere in other financial markets, with the euro down just 0.2 percent at $1.3190. Despite the endless debate over its future, the euro has actually ended the year modestly higher against the dollar.

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