* Senate leaders said close to deal
* Fate of proposal in House remains uncertain
* Borrowing authority set to expire on Thursday
* Markets hold steady on hopes for last-minute deal
By Richard Cowan
WASHINGTON, Oct 16 (Reuters) - The U.S. Senate prepared for a last ditch effort on Wednesday to avoid a historic lapse in the government's borrowing authority, a breach that President Barack Obama has said could lead to default and deliver a damaging blow to the global economy.
After a day of stop-and-go negotiations, the top Democrat and Republican in the U.S. Senate were said to be close to agreeing on a proposal to raise the debt limit - and reopen the partially shuttered government - for consideration by the full Senate later on Wednesday.
The measure's fate remained uncertain in the fractured Republican-controlled House of Representatives, which failed twice Tuesday to produce its own plan.
The Senate was scheduled to meet at noon (1600 GMT), and the House at 10 a.m. (1400 GMT).
With borrowing authority set to run out on Thursday, Senate Majority Leader Harry Reid and Republican leader Senator Mitch McConnell "are very close" to an agreement, Representative Chris Van Hollen of Maryland, a top House Democrat, told MSNBC late Tuesday night.
"I think folks on both sides of the aisle in the Senate are ready to get this done," Republican Senator Saxby Chambliss of Georgia told National Public Radio on Wednesday, a day after chaotic developments frayed the nerves of many members of Congress and global financial markets.
World markets and the dollar were holding steady on Wednesday amid hopes that lawmakers would strike a last-minute deal to prevent the country from defaulting on its debt, although cautious investors are still wary over the final outcome.
Although the cost of insuring U.S. debt hit its highest in over two years, the dollar held its ground against other currencies and U.S. stock index futures signaled a higher start on Wall Street later on Wednesday. European shares also saw a limited morning fall.
"Our assumption is that there will be a plan," John Chambers, chairman of S&P's Sovereign Ratings Committee, told CBS's "This Morning" program on Wednesday.
McConnell and Reid resumed stalled talks after a roller coaster day that saw two separate legislative efforts in the House buried after it became apparent too many Republicans were rebelling against their leaders' plans.
Following weeks of bitter fighting among Democrats and Republicans, the layoff of hundreds of thousands of federal workers and turmoil for stock markets, the deal under discussion - if eventually enacted - would basically give Obama what he has demanded for months: A straight-forward debt limit hike and government funding bill.
The deal would extend U.S. borrowing authority until Feb. 7, although the Treasury Department would have tools to temporarily extend its borrowing capacity beyond that date if Congress failed to act early next year.
With the final details not yet nailed down, as it stood Tuesday night, the agreement envisioned funding government agencies until Jan. 15, ending a partial government shutdown that began with the new fiscal year on Oct. 1.
Senate aides said the two leaders are looking at two possible ways of speeding the legislation through the chamber, which often can bog down for days with procedural hurdles.
Under one scenario, all 100 senators would agree to let Democrats schedule quick votes to pass the bill. That would mean that Tea Party firebrands, such as Republican Senator Ted Cruz, would give up their rights to delay a vote.
Cruz has not publicly announced his intentions but some Senate aides think that the Texas freshman with presidential aspirations has been sending positive signals in recent days.
Cruz and fellow activists in the Tea Party movement late last month delayed passage of a government funding bill as they demanded major changes to Obama's landmark healthcare law.
The deadlock led to federal agency shutdowns as Obama and his fellow Democrats stood firm against changing the law.
The other scenario would have the House send a formal "message" to the Senate to pave the way for quick Senate action, according to a Senate aide who asked not to be identified.
Again, it was not clear whether House Republicans would go along with that option.
BOEHNER'S TOUGH DECISION
Assuming the Senate succeeds, House Speaker John Boehner will have to decide whether to allow passage of a bill that many of his fellow Republicans might oppose, a decision that could impact the top Republican's political future.
Chambliss said the speaker would have to rely on Democratic votes to pass any measure given the tight timeline.
Republican Representative Sean Duffy of Wisconsin said most House conservatives would likely reject the Senate's plan, but "more than likely it'll pass," he told MSNBC's "Morning Joe" on Wednesday.
Uncertainty over Washington's ability to avert a default led Fitch Ratings to warn it could cut the sovereign credit rating of the United States from AAA, citing the political brinkmanship over raising the federal debt ceiling.
House Republicans twice tried to come up with a new compromise but failed to satisfy Obama, Senate Democrats or Republican Tea Party conservatives who are determined to win changes to the president's signature healthcare law before they will agree to concessions on the budget.
The first House Republican attempt was shot down in a closed-door meeting and a second plan was later scuttled after the influential Heritage Action for America, a conservative group, urged a "no" vote because it did not do enough to stop Obama's healthcare law.
If Congress fails to reach a deal by Thursday, checks would likely go out on time for a short while for everyone from bondholders to workers who are owed unemployment benefits. But analysts warn that a default on government obligations could quickly follow, potentially causing the U.S. financial sector to freeze up and threatening the global economy.
The U.S. Treasury Department seized on Fitch's downgrade threat to press Congress. "The announcement reflects the urgency with which Congress should act to remove the threat of default hanging over the economy," a Treasury representative said.
After the Fitch announcement, S&P 500 futures fell 9.6 points while Dow Jones industrial average futures sank 60 points and Nasdaq 100 futures fell 7.5 points.
The crisis is the latest in a series of budget battles in recent years that have hurt consumer confidence and weighed on the economy.
Numerous polls show Republicans have taken a hit in public opinion since the standoff began and the government partially closed. Another Gallup survey this week showed American confidence in the U.S. economy fell another 5 percentage points last week as the government shutdown continued.