Governments and policy makers around the world warned of the risk of financial disaster if Washington fails to raise the U.S. debt ceiling.

As Congress haggled over a deal to stave off the risk of an unprecedented U.S. default, British and Japanese officials on Sunday said failure could hurt households across the globe.

"The world is watching the United States with trepidation, with anxiety, with concern, but also with hope," International Monetary Fund Managing Director Christine Lagarde told CNN.

"Instability is never a good idea, never a good idea. And this level of uncertainty, the trepidation arising from August 2, is bringing about a lot of instability," she added.

U.S. Democrats and Republicans face a Tuesday deadline to reach agreement. The U.S. Treasury has said it will run out of borrowing room on that day although analysts say it may have enough cash to keep servicing its debt and paying its bills through the middle of this month.

The German central bank expressed confidence the United States would avert a debt default.

The key role of the U.S. dollar in global banking and trading means financial markets face the risk of major instability without an 11th-hour agreement.

Senate Leader Harry Reid said he hoped to hold a Senate vote later on Sunday on an emerging deal to raise the debt ceiling, raising hopes the impasse could be broken.

As financial markets opened up for the week in Asia, investors took some relief from the signs of progress and the U.S. dollar strengthened against the Japanese yen, after falling to a four month low on Friday.

"If they get this one wrong and there's a default -- we don't expect that, we think that they will sort this out -- but if that were to happen, it has consequences for every family and every business in this country and all across the world," said Danny Alexander, Chief Secretary to the British Treasury.

"I think in the end the politicians on Capitol Hill can see that the precipice they are looking over is one that they are going to step back from," he told BBC television.

In Tokyo, sources familiar with Japan's international and monetary affairs, also speaking earlier on Sunday, said they were increasingly concerned that markets might be too hopeful about prospects for a lasting solution to the crisis.

Japanese officials still hope Washington can strike a deal and if that proves impossible, will give priority to interest payments to international holders of U.S. Treasury debt to limit the immediate market impact, the sources said.

But Tokyo's concern is that if the crisis drags on without a clear and long-term solution, markets may be thrown into turmoil in the same way that they suffered when U.S. investment bank Lehman Brothers collapsed in September 2008.

"If there is a default, the impact on global markets will be huge," said one of the sources, who declined to be named because of the sensitivity of the matter.

Another Japanese source said, "Nobody thought Washington would let Lehman collapse. But look what happened."

The German central bank said it was monitoring the situation. "Should there really not be a solution, the question arises: what happens then," a German central bank spokesman said. "But I expect ... there will be a solution in the United States either today or in the coming days."


China, which owns well over $1 trillion in U.S. Treasury bonds, has expressed alarm. On Saturday the official People's Daily newspaper, the mouthpiece of the Chinese Communist Party, castigated the U.S. handling of the debt crisis as "irresponsible" and "immoral."

It said the U.S. democratic system was to blame for the "farce," claiming that "not a single representative has considered the world, and even U.S. national interests are being banished from the mind.

On Friday a senior economic policymaker in the euro zone, who declined to be named, expressed surprise and anger that U.S. politicians were "playing chicken" with an issue of such importance for the global economy.

Euro zone leaders are struggling to control sovereign debt crises in several countries in their region, a task complicated by the U.S. debt problem which has added to upward pressure on the yields of government bonds in those weak states.

Central banks around the world are expected to stand ready to provide emergency supplies of money to commercial banks in case the banks become too nervous to lend to each other.

Japan's first defense will be to ensure that Japanese financial institutions have a sufficient supply of dollars, the sources in Tokyo indicated.

The Bank of Japan believes Japanese commercial banks have sufficient dollar cushions but will use its dollar swap arrangement with other central banks to prevent a dollar squeeze in case of market turmoil.

In June, the U.S. Federal Reserve extended liquidity swap arrangement with other big central banks until August 1, 2012.

The Japanese central bank is also prepared to flood markets with yen through its open market operations in case interbank borrowing costs spike, BOJ officials say.

In Europe, there were minor signs of strain in the money markets last week with some banks becoming unable to take out longer-term dollar loans, but the effect was small since banks still expected Washington would reach a deal.

The European Central Bank already offers unlimited euro loans to banks in some of its money market operations as part of its response to past crises, and it could use that policy to cope with any market problems this week.

A spokesman for the Swiss central bank said, "The Swiss National Bank is ready to react appropriately at any time to market disruptions."