(Recasts with U.S. markets, changes byline and dateline; previous LONDON)
By Herbert Lash
NEW YORK, Oct 7 (Reuters) - U.S. and European share prices initially rallied and the euro rose against the dollar on Tuesday after the Federal Reserve took a step to thaw the frozen commercial paper market and restore confidence among panicky investors around the world.
Oil prices rose more than $5 a barrel after Australia's central bank surprised the market with its biggest interest rate cut in 16 years, raising hopes other countries would follow suit to bolster growth, which would boost energy demand.
U.S. government debt prices fell sharply after the Fed's announcement it would create a facility to buy commercial paper, in a move to help a market that is widely used by many companies to fund day-to-day business operations.
The action knocked out any safe-haven bids for short-term government debt.
The 10-year U.S. Treasury note
U.S. stocks opened higher and European shares extended gains on news of the facility, seen as yet another emergency move by U.S. authorities aimed at calming chaotic financial markets.
But U.S. and European stocks gave up much of their early gains.
At 10 a.m., the Dow Jones industrial average <.DJI> was up 38.23 points, or 0.38 percent, at 9,993.73. The Standard & Poor's 500 Index <.SPX> was up 2.76 points, or 0.26 percent, at 1,059.65. The Nasdaq Composite Index <.IXIC> was down 2.36 points, or 0.13 percent, at 1,860.60.
In Europe, the FTSEurofirst 300 <.FTEU3> of top European companies was up 1 percent at 1,015.04 points, trimming gains that had earlier pushed the index more than 2 percent higher.
In the currency market the euro extended gains, rising as much as 3 percent against the yen as the Fed's move boosted risk appetite.
"The Fed announcement to act as a backstop in the CP market is likely to have a positive reaction in regard to sentiment," said Dustin Reid, senior currency strategist, at RBS Greenwich Capital. "In terms of FX, it should help risk appetite on the margin."
The dollar fell against a basket of major currencies, with
the U.S. Dollar Index <.DXY> down 1.03 percent at 80.837. But
it was higher against the yen, last trading at 102.57 yen
The euro
U.S. light sweet crude oil
Spot gold prices
Overnight in Asia, stocks outside Japan rose for the first time in four days. Japan's Nikkei share average <.N225> finished down 2.2 percent at a five-year low, but MSCI's index of Asia-Pacific stocks outside of Japan <.MIAPJ0000PUS> rose 1.5 percent, rebounding from a low last seen in December 2005. (Reporting by Kristina Cooke, Chris Reese, Wanfeng Zhou and Steven C. Johnson in New York and Alex Lawler in London, Editing by Chizu Nomiyama)