GLOBAL MARKETS-Stocks drop, focus on US bailout vote

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* Nikkei at 3-year closing low

* Funding squeeze pushes up dollar

* Commodity prices tumble on view of slower global growth

* Bailout vote uncertain in House of Representatives (Updates prices, adds European outlook)

By Kevin Plumberg

HONG KONG, Oct 3 (Reuters) - Asian stocks fell and gold prices rose on Friday on fears a $700 billion financial rescue bill still needing final U.S. congressional approval may not be enough to keep the global economy from falling into recession.

The Senate has passed the measure, but political brinkmanship continued in Washington after the House of Representatives shook markets earlier this week by rejecting the bill, and passage on Friday was not guaranteed.

European stock market futures STXEc1 pointed to a slightly higher open, ahead of the vote. A second rejection by the House would likely kill the plan and probably unleash panic selling of global equities, blow out credit spreads and drag government bond yields lower.

The flow of credit remained practically frozen in money markets, leading to a scramble for U.S. dollar funding that has the currency on track for its biggest weekly gain in 16 years against a basket of major currencies.

Raw materials prices tumbled on expectations that demand from big consumers such as the United States and China will fall, while a preference for stability pushed up gold by more than 1 percent. Copper prices MCU3 were on track for a record decline this week, down around 14 percent, and oil was down 12.7 percent for the week, its biggest 5-day drop since December 2004.

"Japan's economy isn't good, America isn't good, Europe isn't good. The next to be hit may be emerging economies -- and this will just increase worries for an export-dependent economy like Japan's," said Hiroaki Osakabe, a fund manager at Chibagin Asset Management in Tokyo.

Japan's Nikkei share average finished down 1.9 percent -- its worst close in three years -- with shares of car makers Honda Motor Co and Toyota Motor Corp among the heaviest drags following a big drop in U.S. sales for September.

The MSCI index of Asia-Pacific stocks outside Japan slipped 0.8 percent .MIAPJ0000PUS and lost 6.9 percent on the week. Regional equity markets have outperformed the All-Country World Index, which sank 8.8 percent this week to the lowest in three years .MIWD00000PUS.

Hong Kong's Hang Seng index .HSI dropped 2.6 percent, dragged lower by bank stocks as tight lending conditions spread fears that one of Asia's main financial hubs would be hit hard.

STRESS AND DISARRAY

Credit markets in the Asia-Pacific region reflected stress and disarray as longer-term interbank rates continued to climb and squeeze the financial sector.

The bid on the iTRAXX Asia ex-Japan 5-year credit default index , essentially protection against default, rose about 20 basis points to 655 bps. However, the offer was 700, signalling thin trading and a struggle for price discovery.

"Asia and emerging markets are seeing collateral damage to interbank markets as dollar liquidity evaporates. While equities are inexpensive against bonds, investors should prepare for a hard landing for earnings," said Sean Darby, chief Asia strategist with Nomura in Hong Kong in a note.

Darby believes Asian stocks are oversold but investors should postpone buying until the credit situation clears up.

The euro rebounded after dropping to a 13-month low against the dollar on Thursday on indications the European Central Bank is leaning toward cutting interest rates after bank failures threatened the euro zone economy.

The euro was up 0.3 percent to 145.95 yen after earlier slipping below 144.88 yen to the lowest in two years.

This week investors have continued to find refuge in the yen and the Swiss franc.

The dollar was steady at 105.30 yen and was down 0.3 percent to 1.1320 Swiss francs . The euro rose 0.3 percent to $1.3865 after dropping to around $1.3750 on Thursday.

The main focus on Friday would likely be the vote in the House of Representatives on a White House plan to buy up illiquid securities from battered financial firms.

However, the September U.S. employment report will also be released. Investors expect payrolls shrank by 50,000 jobs.

Government debt was still the favourite bet for investors increasingly intolerant of having risk in their portfolios.

The 10-year Japanese government bond future 2JGBv1 was up 0.6 point at 137.89, rising for a second day.

The 10-year U.S. Treasury note slipped 7/32 in price, for a yield of 3.65 percent , up from 3.63 percent late on Thursday in New York. The highly liquid bills market, which investors have been using as an alternative source of short-term investment, saw solid demand.

The 1-month bill yield , which moves in the opposite direction of the price, slipped 3 bps to 0.22 percent.

Spot gold climbed 0.8 percent to $842 an ounce but is well off a 2-month high of $920 an ounce earlier this week.

The November U.S. light crude contract CLc1 fell 75 cents to $93.22 a barrel, creeping toward a 7-month low of $90.51 hit on Sept. 16.