By Elizabeth Howcroft

LONDON European shares opened higher on Thursday and the U.S. dollar rose to a seven-week high, as traders bet that politicians in the United States would reach a deal to avoid a debt default.

Wall Street closed sharply higher on Wednesday and the positive market sentiment continued during Asian trading, with Japan's Nikkei hitting a new 20-month high, after President Joe Biden and top U.S. congressional Republican Kevin McCarthy expressed their determination to reach a deal soon to raise the government's $31.4 trillion debt ceiling.

At 0833 GMT, the MSCI world equity index was up 0.2% on the day. Europe's STOXX 600 was up 0.6% and London's FTSE 100 was up 0.7%. Germany's DAX climbed to its highest in more than a year.

Kiran Ganesh, a multi-asset strategist at UBS, said markets were taking confidence from Biden's decision to cut short a trip to Asia in order to return to Washington on Sunday, and McCarthy saying that a deal this week was "doable".

"Default is one of those low-probablity, high-impact events," Ganesh said.

"Maybe that low probability got even lower, and removing that tail risk is a positive, because of course if you did get a default or delayed payments then that would likely tip the U.S. into recession."

The U.S. dollar index was up 0.2% at around 103.09, having hit as high as 103.13 earlier in the session. It hit its strongest since December against the Japanese yen, at 137.935. Euro-dollar was down around 0.2%, at $1.0817.

INFLATION

Analysts have attributed recent dollar strength to its appeal as a safe haven, as well as concerns that persistent inflation may prompt the U.S. Federal Reserve to further raise interest rates.

China's yuan hit its weakest against the dollar since December, hurt by signs that the country's post-COVID economic recovery is slowing.

U.S. initial jobless claims data are due later in the session. Recent economic data has raised expectations that the Fed will keep interest rates higher for longer, with some investors betting another hike in June is not off the table.

"In our base case, we think the Fed is now going to be on pause for the next few months to see how far inflation comes down," said UBS's Ganesh.

"But if markets do get into more positive spirits as a result of perhaps the debt ceiling risk going away, then we could see more of that rate hike probability getting priced in for June."

Meanwhile, the European Central Bank will have to keep raising rates to bring inflation down in the eurozone, its vice president Luis de Guindos said.

Optimism that the U.S. would avoid a default boosted euro zone government bond yields. The benchmark German 10-year yield up 6 basis points at 2.395%.

But the U.S. 10-year yield was little changed, at around 3.5887%.

Oil prices eased, with Brent crude futures down 0.6% at $76.52 a barrel, while U.S. West Texas Intermediate crude was down 0.6% at $72.42.

Turkey's lira was close to an all-time low, having weakened steadily since Sunday's inconclusive presidential election, which saw incumbent Tayyip Erdogan - known for his unorthodox economic policies - take the lead. A runoff will take place on May 28.

(Reporting by Elizabeth Howcroft and Kevin Buckland; Editing by Gareth Jones)