Asian shares fell on Monday as uncertainty remained over how euro zone leaders would respond to mounting funding difficulties for European banks, and an apparent failure by U.S. politicians to agree on deficit reduction hurt sentiment.

The U.S. congressional deficit-reduction committee was set to formally announce its three-month-long effort to bridge partisan differences over taxation and spending has failed, aides told Reuters.

Automatic spending cuts of $1.2 trillion over a decade are due to start in 2013, after elections in 2012, if the super committee of six Democrats and six Republicans cannot agree.

It is a minor negative, there are a few questions to be asked -- do Moody's and Fitch for example move to downgrade the U.S., said HSBC's head of global equity strategy, Garry Evans.

MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> extended its losses to fall 1.7 percent, after posting its biggest weekly loss in about two months last week. Japan's Nikkei <.N225> fell 0.3 percent. <.T>

European shares were set to fall, with spreadbetters seeing London's FTSE 100 <.FTSE> opening down 0.9 percent and Frankfurt's DAX <.GDAXI> and Paris' CAC-40 <.FCHI> down 0.8 percent. <.EU> <.L>

Comments from Chinese Vice Premier Wang Qishan warning that the global economic outlook was grim also hurt Asian equity markets, particularly Hong Kong, where the Hang Seng index <.HSI> fell 1.9 percent.

LOW EXPECTATIONS

Market expectations for a U.S. deficit deal were low, but a failure of the committee could remind investors of the risks posed by a dysfunctional U.S. government.

The committee was created after a battle over the federal government's debt ceiling nearly shut it down and led to a first-ever cut in the United States' AAA credit rating by Standard & Poor's in the summer, roiling financial markets.

Europe's messy politics, however,, appeared to be heading in the direction of carrying out vital fiscal reforms, offering some relief to investors.

The euro drifted 0.1 percent higher to $1.3525 on Monday, partly helped by a 0.1 percent drop in the dollar index <.DXY> against six key currencies.

In Spain, the centre-right opposition People's Party won a crushing election victory and was expected to push through drastic austerity measures to try to prevent Spain being sucked deeper into the debt storm threatening the euro zone.

Those policies would undoubtedly be welcomed by markets, yet may not be enough to stabilise the Spanish sovereign, Barclays Capital analysts said in a research note. Ultimately, we think it is likely that the ECB will need to step up its support.

In Italy, Prime Minister Mario Monti won an overwhelming vote of confidence on Friday after warning politicians against sabotaging a sweeping package of fiscal reforms.

But political wrangling in Greece, which has teetered on the brink of default and set off the panic selling now widespread in bonds of other highly-indebted euro zone members, threatened the new prime minister's bid to win vital bailout funds from European leaders.

PRESSURE ON ECB RISING

Italian and Spanish government bond yields eased on Friday, after the European Central Bank intervened in markets to alleviate pressure from investors demanding higher premiums.

The ECB has resisted rising pressures to step up purchases of euro zone sovereign debt, or the idea of lending to the International Monetary Fund to bail out troubled euro zone economies, despite a growing market perception of the bank as the last hope to stop the debt crisis from spreading globally.

Reflecting worsening dollar funding strains for European banks, euro/dollar three-month cross-currency basis swaps widened further on Friday to -138.50 basis points, the most since the height of the Lehman crisis in 2008.

The premium for the three-month dollar offered interbank lending rate hit the widest since June 2009.

The probability is quite high that European woes will further shrink global capital markets, aggravating interbank funding strains and drying up investment flows, said Bob Takai, general manager of Sumitomo Corp's energy division.

Sentiment remained cautious in Asian credit markets, with spreads on the iTraxx Asia ex-Japan investment grade index widening around 3 basis points on Monday.

In a sign of risk aversion, investors put fresh cash into U.S. equities, bonds and precious metals funds, along with a big allocation to inflation-protected bond funds to 80-week high of $512 million in the week ended November 16, data from EPFR Global showed on Friday.

(Editing by Alex Richardson)