Concerns about the deadlock in crucial U.S. budget talks capped gains in world equity markets on Friday, while falling yields on Spanish and Italian bonds kept the euro near a one-month high.

Markets are on edge over the lack of progress by political leaders in Washington as a failure to resolve their differences by year-end would trigger automatic spending cuts and tax rises that will tip the U.S. economy into recession.

Many investors also expect that once the so called 'fiscal cliff' is resolved, the brighter economic outlook for China and the U.S., along with signs of stabilization in the euro zone will fuel a major rally in riskier assets like equities.

"The market is subject to mood swings by investors who pay close attention to small developments in the U.S. budget talks," said Takuya Takahashi, an analyst at Daiwa Securities.

In the latest development the leading Republican politician, House of Representatives Speaker John Boehner, dampened hopes for a early deal on Thursday, less than 24 hours after he said he was "optimistic" about reaching a pact.

The lack of progress saw European shares edge lower at the start of trading but they remain on course for their best month since August and their sixth straight monthly gain.

The FTSEurofirst 300 index <.FTEU3> of top European shares was down 0.2 percent at 1,119.74 in early trade, having jumped 1.1 percent on Thursday to its highest close since July 2011. London's FTSE 100 , Paris's CAC-40 and Frankfurt's DAX were flat to slightly lower.

A 0.2 percent drop in U.S. stock futures also hinted at a weaker Wall Street open.

Earlier MSCI's broadest index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> rose 0.6 percent to its highest since March 1, and was on course for a monthly gain of 2.1 percent.

EUROPEAN FEARS EASE

The euro was up 0.3 percent to just over $1.30 and at a seven-month high against the yen 107.55 yen as hopes the euro zone's crisis was easing supported demand.

A deal agreed earlier this week to release aid funds to Greece and strong demand at an Italian bond auction that cut Rome's borrowing costs to a two year low, have encouraged investors into Europe's peripheral markets and the euro.

Amid the unclear prospects for the U.S. budget talks and the better outlook for Europe's debt crisis, investors sought trade incentives from data out of Asian countries on Friday and Saturday that could offer signals for the likely direction of global economic growth.

India's economy grew at a lower-than-expected annual 5.3 percent in the quarter ending in September, against analysts' forecasts of 5.4 percent. Asia's third largest economy is still growing faster than many other major economies, but it has slowed from 6.5 percent in the 2011/12 fiscal year.

The data followed mixed reports from Japan, the world's third-largest economy, earlier in the day.

Japanese industrial output unexpectedly rose 1.8 percent in October, the first increase in four months, suggesting the negative impact of the global slowdown and a diplomatic row with China may have run its course.

But Japanese manufacturing activity contracted in November at the fastest pace in 19 months, according to a survey indicating it was hurt by falling exports, weak domestic demand and declining capital expenditure.

In South Korea, another big export-reliant economy, industrial output grew for a second month in a row in October, backing expectations for a recovery in the current quarter.

On Saturday, China will release the official manufacturing PMI for November, which is likely to show factory activity expanding at its fastest pace in seven months.

(Reporting by Richard Hubbard; editing by Philippa Fletcher)