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Fear of stimulus taper hits world stocks

NEW YORK (Reuters) - Fear that the Federal Reserve will scale back its stimulus as the U.S. economy recovers hit world stock markets on Tuesday, with European equities falling the most since August, while safe havens such as the yen and Treasuries rose.

Investors expect the Fed to start paring its $85 billion-a-month program if Friday's U.S. jobs report for November shows encouraging growth. Many think a cut-back could come in March, though some expect it by January, after U.S. data on Monday pointed to steadying growth.

"It's not a question of if, it's a question of when, and you always have the question of how much of it is real and how much of it is emotional in nature?" said Gordon Charlop, managing director at Rosenblatt Securities in New York.

Gold, which like stocks has been a key beneficiary of the U.S. stimulus due to inflationary concerns, traded not far from Monday's near 5-month low. Oil approached a 3-month high as the U.S. recovery boosted the demand outlook for energy amid supply outages in Libya.

The dollar slipped against the yen as investors took profits from a month-long rally in the currency, driven by speculation of an imminent reduction in the Fed stimulus.

While the direction was decidedly down in most markets, trading was thin as caution prevailed ahead of Friday's U.S. jobs report and after eight straight weeks of gains for the S&P.

"With the market being up so much in November, we're seeing some healthy profit-taking. It's been a very strong year in equities," said Eric Marshall, director of research at Hodges Capital Management in Dallas, Texas.

In U.S. trading, the S&P 500 was on track for its third consecutive decline, while a measure of European stocks lost 1.5 percent.

Wall Street's Dow Jones industrial average was down 117.88 points, or 0.74 percent, at 15,890.89. The Standard & Poor's 500 Index was down 8.86 points, or 0.49 percent, at 1,792.04. The Nasdaq Composite Index was down 14.86 points, or 0.37 percent, at 4,030.40.

U.S. bond prices edged higher. The benchmark 10-year Treasury note was up 8/32, its yield at 2.7716 percent.

The yen rose 0.5 percent against the dollar to 102.37 yen, after reaching 103.37 in Asian trading, Reuters data showed. That was close to the 2013 high of 103.73 yen, a level dollar bulls had been targeting.

The yen tumbled against both the euro and dollar on Monday after Reuters reported exclusively that the Bank of Japan was looking to expand its $70-billion-a-month stimulus.

European shares were rattled for the second day, with Paris's CAC 40 sinking nearly 3 percent. The pan-regional FTSEurofirst closed down 1.5 percent in its weakest day since August.

New fears over Europe surfaced as the cost of insuring Ukraine's government debt against default jumped, leaving it a whisker from 2009 peak levels.

Political worries also clouded markets as President Viktor Yanukovich left Ukraine for a state visit to China, amid protests about his decision to abandon an EU integration pact.

But investors reacted well to a debt swap by Portugal aimed at preparing for a possible return to markets next year. Portugal's bonds and stocks outperformed.

"Portuguese bonds are actually posting a rally, reflecting the fact that after this morning's exchange, next year's funding is going to be less challenging," said Luca Cazzulani, strategist at UniCredit.

MSCI's world stock index, which tracks 45 countries, was down 0.6 percent, supported by early gains in Asia. News of Japan's potential stimulus widening had lifted the Nikkei toward a 6-year high.

The European Central Bank and Bank of England both meet on Thursday, with the ECB in particular focus after last month's surprise interest rate cut.

The euro rose 0.4 percent to $1.3600 on expectations the ECB would leave interest rates unchanged after above-forecast inflation data last Friday.

The Australian dollar dropped toward a 3-month low after the Reserve Bank of Australia left rates on hold and said the currency was "still uncomfortably high.

Spot gold rebounded slightly to above $1,222 an ounce while remaining close to the early July low hit on Monday.

Benchmark Brent crude rose 1.2 percent to near $113 a barrel. U.S. crude prices settled up 2.4 percent at $96.04.