* U.S. budget deal bolsters view of early stimulus reduction * Short-covering rally in gold falters as Fed meeting looms * Indian demand soft due to tight supply (Releads, updates prices, adds comment) By Julia Fioretti LONDON, Dec 12 (Reuters) - Gold prices slid more than 1 percent on Thursday, with a short-covering rally fizzling out as expectations grew that the Federal Reserve would reduce its huge stimulus programme after a provisional budget deal in Washington. The bipartisan budget agreement is seen as increasing the chances of an earlier taper, as investors wait to see whether the Fed will start trimming its $85 billion monthly bond purchases at its Dec. 17-18 meeting, or in January or March next year. Spot gold was down 1.3 percent at $1,235.61 an ounce by 1242 GMT, pulling back from a three-week high of $1,267.26 hit on Tuesday on the back of a wave of short covering. "Since there was very little behind the surge higher, aside from a weaker dollar, the short-term longs will be unwinding, while physical activity slowed," VTB Capital analyst Andrey Kryuchenkov said. The retracement could take prices back to the $1,220 an ounce level, he said. "We will sidetrack near December lows ahead of the Fed meeting, still hostage to dollar sentiment," he said. U.S. Gold futures for February delivery were also down $21.20 at $1,236.00. Readings on the U.S. economy later are being closely watched for their impact on monetary policy. Thursday's data focus will be on U.S. weekly jobless claims numbers for the week ended Dec. 7 and U.S. retail sales data for November. Expectations that the Fed will taper its stimulus programme have helped knock gold 25 percent lower this year. Ultra-loose monetary policy is seen as bullion-friendly, as it keeps interest rates at rock bottom while stoking inflation fears. This week's provisional budget deal in Washington this week eased some of the fiscal drag on the U.S. economy, and was seen as increasing the likelihood that the Fed will taper soon. "The U.S. budget agreement takes away another part of uncertainty for the Fed because they don't have to worry about another government shutdown," said Standard Bank analyst Walter de Wet. "That on balance goes in favour of the argument that the Fed is going to start tapering sooner rather than later." INDIAN DEMAND SOFT On the physical markets, buying in major consumer India remained soft on Thursday as dealers struggled to source metal. "Supplies are short in the market," Harshad Ajmera, proprietor of JJ Gold House, said, adding that premiums were steady at $120 an ounce on London prices. Last week they hit a record $160 an ounce. Imports into India have fallen sharply this year after the Indian government lifted import duty to 10 percent earlier this year and tied imports volumes to exports, in a bid to curb a rising trade gap. Investor interest remained lacklustre, with holdings of the world's largest gold-backed exchange-traded fund, New York's SPDR Gold Shares, down 2.1 tonnes on Wednesday. This year has seen heavy liquidation of ETF holdings, with the SPDR's holdings dropping by more than 500 tonnes to their lowest in nearly five years. Other precious metals were also feeling the pressure in the markets, with silver down 2.6 percent on the day to $19.74 per ounce, while platinum was down 0.7 percent to $1,370.24 and palladium down 1.2 percent to $726.72. South Africa's Impala Platinum, the world's second largest producer of the precious metal, said wage talks with the AMCU union remained deadlocked after the two sides met on Thursday, and negotiations would resume in 2014. (Additional reporting by Jan Harvey and Clara Denina in London, A. Ananthalakshmi in Singapore; editing by Keiron Henderson)

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