LONDON — Financial markets remained fixated on developments in Washington on Thursday as the partial shutdown of the U.S. government entered its third day and showed few signs of being resolved soon.
The mood remained cautious after a closely-watched gauge of the U.S. services sector fell sharply and amid fears that the U.S. could be heading for an even bigger economic shock. American lawmakers have to agree on an increase in the debt ceiling by Oct. 17 or the world's largest economy may be in default of its debts.
Congress must periodically raise the limit on government borrowing, but the once-routine matter has become the subject of bitter fights between Republicans and Democrats.
As well as undermining confidence in the ability of the U.S. to pay back what it owes, a U.S. default could send shockwaves round the world economy, threatening the patchy recovery.
On Wednesday, President Barack Obama met with lawmakers in Congress but little of substance appeared to have been achieved in the dispute that has idled hundreds of thousands of workers and curtailed services nationwide.
"This failure in bipartisan politics could have wider implications than merely shutting down the U.S. government," said Alex Conroy, a sales trader at Spreadex. "If both sides continue to play chicken with each other and fail to agree before the debt ceiling deadline, the government would only have cash left to pay bills and the chance of default goes from unthinkable to near certainty."
In Europe, Germany's DAX closed down 0.4 percent at 8,597.91 while the CAC-40 in France fell 0.7 percent to 4,127.98. The FTSE 100 index of leading British shares bucked the trend somewhat, ending 0.2 percent higher at 6,449.04.
In the U.S., the Dow Jones industrial average was down 1 percent at 14,985 while the broader S&P 500 index fell 1.1 percent to 1,676.
Apart from developments in Washington, traders had data releases to digest, too.
In Europe, trading was unaffected by figures showing that retail sales across the 17 European Union countries that use the euro grew by a better than expected monthly rate of 0.7 percent in August.
But in the U.S., a big fall in the Institute for Supply Management's index for the services sector added to the selling pressure in stock markets. Its main index fell to 54.4 points in September from the previous month's 58.6, which was the highest since December 2005. Though anything above 50 indicates expansion, the survey indicates growth waned in the run-up to the partial shutdown of the U.S. government.
The economic data calendar has been thrown into confusion as Friday's scheduled nonfarm payrolls report — often the most important data release of the month — has been postponed because of the partial government shutdown.
One offshoot of the U.S. budget stalemate is that investors think it's now less likely that the U.S. Federal Reserve will start to reduce its monetary stimulus this month or even this year, especially as Friday's payrolls report for September won't now be released. For much of the summer, investors thought a tapering of the stimulus would happen this year.
"The longer this goes on with the Fed feeling partially blind on assessing the economy, the further away Fed tapering becomes," said Derek Halpenny, an analyst at the Bank of Tokyo-Mitsubishi UFJ.
The dollar has been on the retreat this week amid the budget crisis. The euro headed up toward its year-high, trading another 0.3 percent higher at $1.3628. The dollar faltered against the yen too, trading 0.1 percent lower at 97.25 yen.
Earlier, trading in Asia was fairly mixed. Though Hong Kong's Hang Seng rose 1 percent to 23,214.40, Japan's Nikkei 225 index fell 0.1 percent to close at 14,157.25. Australia's S&P/ASX 200 added 0.4 percent to 5,234.90. Markets in mainland China and South Korea were closed for public holidays.