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Euro markets steady ahead of Spain auction, ECB

(Reuters) - Euro zone sovereign bond markets steadied Thursday ahead of a crucial European Central Bank policy-setting meeting that investors hope will signal a more aggressive approach to fighting the currency area's debt crisis.

Yields of Italian and Spanish 10-year bonds fell in early trading before an auction in which Spain planned to sell up to 3.5 billion euros ($5 billion) of government paper after crisis telephone consultations with European Union authorities.

Japanese authorities acted to bring down the strong yen, joining Switzerland in efforts to tame currencies buoyed by safe-haven demand from investors fretting about the health of the global economy and the euro zone's debt woes.

All eyes were on the ECB, with the chief European economist of credit ratings agency Standard & Poor's urging it to re-activate its bond-buying program to stabilize battered euro zone sovereigns.

"Markets are still moving so we need someone to intervene," S&P's Jean-Michel Six said. "The only effective fireman capable of rushing out of the fire station at top speed is the European Central Bank, which has played an admirable role since the start of the crisis to calm markets.

He told France-Inter radio that until a contagion-fighting plan adopted by euro zone leaders last month came into effect, which requires parliamentary approval in some countries, the ECB had to play an interim role.

The controversial ECB program has been dormant for four months and there is strong opposition to reviving it among guardians of central banking orthodoxy in Germany who argue it compromises the core mission of fighting inflation.

The ECB bought 76 billion euros of sovereign bonds, believed to be only Greek, Irish and Portuguese, to stabilize markets last year but critics said the Securities Market Program had only limited, short-term impact and did not prevent any of those countries from requiring EU/IMF bailouts.

Spanish Economy Minister Elena Salgado, speaking on Wednesday night after a crisis meeting on the economy with Prime Minister Jose Luis Rodriguez Zapatero, said the bond sale would take place as scheduled despite a surge in Spanish and Italian bond yields to 14-year highs in the past several days.

"We think the tensions will last a few more days, but the bond auction will go ahead Thursday," Salgado said.

The yield on Spain's 10-year bonds climbed as high as 6.50 percent Wednesday because of investor doubts about Madrid's ability to continue financing its debt over the long term, before drifting back to close at 6.27 percent. It fell a further 21 basis points against benchmark German Bunds in early Thursday trading.

Italy's 10-year yield fell back below the psychologically important 6.0 percent threshold, with some traders saying they expected the ECB could act, either with a longer term repo or secondary market bond-buying.

"DESPERATE"

Analysts say that if yields go much higher and stay there, markets could force Spain, the euro zone's fourth biggest economy, to follow Greece, Ireland and Portugal in seeking an international bailout.

"Hearing Zapatero had canceled his holidays showed the situation was desperate. The 7 percent (yield) mark is a psychological barrier and is just not sustainable because it's far too costly to finance at these levels," said Jo Tomkins, analyst at consultancy 4Cast.

Euro zone leaders agreed at a summit last month to give the bloc's bailout fund sweeping new powers to help indebted states and intervene in the bond market, but the changes are unlikely to be passed by national parliaments until late September at the earliest.

If the ECB does not revive the program, central bank president Jean-Claude Trichet may at least indicate willingness to use it if the crisis worsens, some analysts believe.

The ECB, which has raised official interest rates twice this year, may also signal it will put any further tightening on hold because of slowing economic growth in the euro zone and globally, even though inflation is well above target.

Japan sold one trillion yen ($12.6 billion) and its central bank eased monetary policy Thursday to try to push down the yen against the dollar and euro.

Economy Minister Kaoru Yosano said policymakers of major economies needed to discuss currencies at either Group of Seven or Group of 20 level -- the first official call for multilateral action since twin crises over U.S. and euro zone debt became acute last month.

Official sources in several G7 countries said Wednesday they were not aware of any move so far to involve the G7 or G20, but that France, which holds the chair of both groups this year, might consult those forums if the turmoil persists.

In Italy, the euro zone's third biggest economy, Prime Minister Silvio Berlusconi promised Wednesday to step up economic reforms and called for a broad-based effort in the country to fight the market turmoil.

"The government and parliament will act, I hope, with a large political and social consensus to fight every threat to our financial stability. Today more than ever, we need to act all together," said Berlusconi, in a speech which did not give substantial new details on policy.

Berlusconi is due to meet employers' groups and unions on Thursday to try to thrash out a plan to stimulate the economy. But the head of the largest union, the left-wing CGIL, responded coolly to his speech.

Susanna Camusso said it lacked concrete proposals, and that negotiations were already "getting off on the wrong foot." The leader of the opposition Democratic party, Pierluigi Bersani, said Berlusconi should resign.

In addition to Italy and Spain, some investors are becoming jittery about the finances of France, the euro zone's second biggest economy. The spread of 10-year French government bonds above German Bunds hit a euro lifetime high of 0.81 percentage point Wednesday.

This is problematic partly because any lasting solution to the euro zone's crisis may have to involve a drastic expansion of its 440 billion euro bailout fund. That would put a greater financial burden on France, a big contributor to the fund, and could push up its yields further.

GM profit nearly doubles on stronger pricing


(Reuters) - General Motors Co's quarterly profit nearly doubled, beating expectations, as the top U.S. automaker took a larger share of sales globally and raised prices on its vehicles.


Coming out of bankruptcy, GM Chief Executive Dan Akerson and other executives said the company had stripped out enough costs to recession-proof the business so it could thrive even in a weak auto market. The industry's sales slump in the second quarter and the risk of a double-dip recession could provide the first major test for that claim.

GM Chief Financial Officer Dan Ammann called the quarter a "good building block" for the company.

GM is pushing heavily into smaller, more fuel-efficient cars like the popular Chevrolet Cruze, but a good portion of its profit still relies heavily on sales of more profitable trucks in the U.S. market.

Net income in the second quarter rose to $2.52 billion, or $1.54 per share, from $1.33 billion, or 85 cents per share, a year earlier.

Analysts polled by Thomson Reuters I/B/E/S had expected $1.20 per share on average.

Revenue rose 19 percent to $39.4 billion, above the $36.74 billion analysts had expected during a quarter in which U.S. auto sales hit a soft patch.

GM shares rose 2 percent in premarket trading.

The results represent the second full quarter since GM's initial public stock offering last November and a restructuring intended to keep the largest U.S. automaker profitable through the industry's punishing boom-and-bust cycles.

GM emerged from bankruptcy in 2009 after a $52 billion taxpayer-funded bailout orchestrated by the Obama administration. The U.S. Treasury still owns 32 percent of GM's common shares.

The company boosted its second-quarter earnings before interest and taxes by $1 billion by pushing through higher prices on its vehicles globally.

However, those gains came as its Japanese rivals, led by Toyota Motor Corp, struggled with fewer vehicles to sell due to the earthquake in Japan in March.

Analysts worry that if the U.S. recovery hits a pothole in the second half, GM could be forced to raise incentives on its vehicles to lure shoppers. GM's first-quarter results were marred by heavy incentives, but the automaker dialed back those deals.

Italy prosecutors seize Moody's, S&P documents

Aug 4 (Reuters) - Italian prosecutors have seized documents at the offices of rating agencies Moody's and Standard & Poor's in a probe over suspected "anomalous" fluctuations in Italian share prices, a prosecutor said on Thursday.

The measure is aimed at "verifying whether these agencies respect regulations as they carry out their work," Carlo Maria Capistro, who heads the prosecutors' office in the southern town of Trani which is leading the probe, told Reuters.

The documents were seized at the Milan offices of the two agencies on Wednesday, he said, adding that prosecutors had also asked Italian market regulator Consob to provide documents relating to their registration in Italy.

S&P in Italy said in a statement it believed the probe was "groundless."

"We strongly defend our work, our reputation and that of our analysts," it said.

Moody's said it "takes its responsibilities surrounding the dissemination of market sensitive information very seriously and is cooperating with the authorities."

The Trani prosecutors have opened two probes -- one for each rating agency -- after a complaint by two consumer groups over the impact of their reports about Italy on Milan stock prices.

The first complaint was filed against Moody's after it published a report in May 2010 about the risk of contagion for Italian banks from the Greek crisis.

A second complaint filed in May this year targeted Standard & Poor's after it threatened to downgrade Italy's credit rating because of its huge public debt.

The prosecutors are also investigating whether any crimes were committed during a sell-off in Italian assets on July 8 and July 11 as fears spread that the euro zone's third largest economy is being sucked into the widening debt crisis.

One of the consumer groups behind the complaints said the probe was aimed at finding out whether the market's sharp drop was due to a "precise scheme by hedge funds and other unidentified players that could be linked to the negative comments about Italian public finances by the rating agencies."

Consob last month summoned Moody's and S&P for meetings and urged them not to release their statements during market hours.

Japan signals readiness to intervene again; market jittery

(Reuters) - Japan's finance minister said he was closely watching yen moves on Friday, signaling a readiness to continue selling the currency after intervention on Thursday that likely totaled a record amount around 4.5 trillion yen ($56 billion).

Japanese authorities intervened on Thursday and the central bank eased monetary policy to reduce pressure on the export-reliant economy after the yen surged close to a record high with investors buying it as a refuge from the fiscal and economic woes in Europe and the United States.

"There's no change to our basic stance that we want to monitor markets closely," Finance Minister Yoshihiko Noda said on Friday.

"It's better to wait for a little while before judging the impact of intervention," he told a news conference.

Markets remained jittery.

The Japanese currency plunged nearly a full yen against the dollar at one point on Friday, spurring market talk that Japan had intervened again. It quickly bounced back, so traders said it was unlikely to have been the result of intervention. A Finance Ministry official declined to comment.

Earlier, a comment by Noda that he wanted to spend more time determining the effect of Tokyo's action briefly pushed the yen up against the dollar as market players interpreted it as a sign Tokyo may hold off intervention in the near future.

"Of course, we have to watch currencies, but the Dow (industrial average) fell a lot, so today I also want to watch the stock market."

Thursday's intervention briefly pushed the dollar above 80 yen. It fell back to trade around 78.45 yen.

Money market data released by the Bank of Japan late on Friday showed that Japan's yen-selling intervention the previous day may have totaled a record amount around 4.46-4.66 trillion yen.

World stocks plunged to new lows for the year on Thursday with a sell-off in markets accelerating sharply as investors fretted about the outlook for the global economy and piled into safe-haven bonds. The overnight sell-off pushed the Nikkei share average .N225 down sharply on Friday.

Noda offered no sign that financial officials from the Group of Seven or Group of 20 leading economies are considering discussing the global slowdown and market instability, or whether Tokyo may be initiating such discussions.

"I agree that these subjects should be discussed. We have the G20 meeting in September. I am sure these subjects will come up at a lot of international meetings," Noda said.

"Each problem is important, but how to prioritize these issues is something to discuss from here on," Noda said in response to questions on whether G20 needed to discuss currencies, the sovereign debt crisis and the U.S. economy.

Japanese officials have not been clear about whether they obtained consent from G7 counterparts to conduct solo intervention.

Asked about the cool reception of officials in Europe and the United States to Japan's intervention, Noda said: "We are communicating, but I won't comment on each country's stance."

Economics Minister Kaoru Yosano warned markets on Friday that they should not assume that Tokyo is done with stepping into the market, while stressing again the need for Japan, Europe and the United States to adopt common policies to contain the pessimism about the global economy. ($1 = 79.020 Japanese Yen)

Advisers steer clients to safer havens in stormy market

(Reuters) - Where can investors hide when even gold and cash look dicey?

Some financial advisers were answering phone calls from panicky clients Thursday as stocks dropped 500 points, gold lost its safe-haven glitter and money markets got the jitters.

Michael Kay, a financial adviser at Financial Focus in Livingston, New Jersey, talked a client off the proverbial ledge in the morning as the market resumed its sharp downward trajectory. The client wanted to liquidate his portfolio and invest in gold.

Kay's advice? "If you think it's the end of the world, buy Progresso soup in pop-top cans because it's more valuable than gold. You can't eat gold."

So what should investors be doing as the markets zig and zag?

Alan Haft, a financial adviser in Newport Beach, California, is getting defensive. He has moved about $15 million of his client's portfolios into cash-like investments since early July. He's put much of that cash to work in the Vanguard Short-Term Treasury Fund.

"People are skittish, but the U.S. Treasury is still the safest place when you compare what is out there," Haft says.

Like the von Trapp family in the "Sound of Music," Haft sees Switzerland as a safe haven. He's parking money in Swiss fixed annuities, which are highly liquid but can only be purchased through an intermediary.

"The Swiss Franc has been rocking; many of my investors love the off-shore nature of it," Haft says. He also likes the CurrencyShares Swiss Franc ETF.

In the past few weeks, Haft says he also put $5 million into the WellsFargo Advantage Short-Term Muni Fund because the duration is "super-low" which means interest-rate risk is minimal.

"The whole thing about rising interest rates is that on one hand the economy is not getting any better (which means rates should stay low). But on the other hand with deficit stuff, rates should climb, so it's a quandary," Haft says.

FINDING ALTERNATIVES

Despite all of the turmoil in Italy and Greece, Bradley Bofford, a financial adviser at Financial Principles in Fairfield, New Jersey, says he has not received any client calls about the safety of money market instruments. But his firm has been reaching out to some clients with accounts that exceed the $250,000 FDIC limit. For these high-end clients, he recommends a Certificate of Deposit Account Registry Service, also known as CDARS.

CDARS (CDARS - The Certificate of Deposit Account Registry Service) work like super-sized CDs but offer insurance coverage up to $50 million. They rose in popularity during the 2008 financial crisis. Money is spread around in chunks across a network of "well-capitalized" banks, with maturities of four weeks to five years. The trade-off is a lower yields than traditional CDs.

According to Bankrate.com, the average one-year certificate of deposit is yielding 0.91 percent. One-year CDARS, by comparison, pay 0.26 percent, Bofford says.

TWO STYLES: STAY PUT OR ACT NOW

There are two main camps among advisers: the do-nothing crowd and the do-more crowd.

Over the last three weeks, financial adviser Rich Brooks says he has not had a single client conversation that didn't involve talking about market volatility.

So maybe that's why no one called during Thursday's big drop since it was not a huge surprise, says Brooks, who is vice president for investment management at Blankenship & Foster, which has $320 million under management for 225 clients in Solana Beach, California.

"The current sell-off hasn't really shaken our clients. If we were sitting here today asking why Congress didn't come to a budget deal, then maybe. But we've been working hard to prepare them for the headwinds," Brooks says.

Among the 'do-more' crowd is Pat Dorsey, Morningstar's former director of equity research and now vice chairman of Sanibel Captiva Trust Company, which has $500 million under management.

"My sense is that the best opportunities are going to be European multinationals…which get the bulk of revenue from outside Europe, like Siemens, Nestle or Novartis. It's not like Japanese consumers are going to stop eating chocolate," he says. "If you're willing to step up to the plate a little bit, there are interesting ways to take advantage of this volatility."

STOCKS MORE ATTRACTIVE?

Another make-a-move adviser is Tim Courtney, chief investment officer at Burns Advisory Group, with offices in Oklahoma and Connecticut. At a price-to-earnings ratio of 13.98, the S&P 500 is cheaper today on a trailing 12-month basis than it has been in the past 20 years. What's more, in 1990 you could buy a 10-year U.S. Treasury note that yielded 8.6 percent -- a full six percentage points higher than what you can get today.

Courtney says there's no question stocks offer a great relative value at these levels despite the continued downturn. (And he'd like to know where investors that are pulling out after a 10 percent drop are going to put their money, or when they plan to get back in.) If you can look past the next week or month, stocks are "super attractive," he says.

William Suplee IV, a financial adviser at Structured Asset Management in Paoli, Pennsylvania, says 20 percent of his clients are worried about their portfolios right now. But a whopping 70 percent are sitting tight, "having lived through this several times previously."

And the rest - well, they are using this dip as a buying opportunity," he says. Their secret? "Strong stomachs," he says.

Wall St rebounds after sell-off, Berlusconi budget announcement

(Reuters) - U.S. stocks rose in volatile trade on Friday as investors saw a buying opportunity following the sharp sell-off that took the S&P 500 down 10 percent over the last 10 sessions.

The stock market extended its rebound after Italian Prime Minister Silvio Berlusconi said his country will introduce a constitutional principle of a balanced budget, adding that: "We will accelerate measures" in an austerity program, with the "aim of a balanced budget in 2013."

Helping the market, sources said the European Central Bank was ready to buy Italian and Spanish bonds if Berlusconi commits to bringing forward specific reforms.

"You are making or have made a tradeable low and are going to get a throwback rally," said Jeffrey Saut, Raymond James Financial chief investment strategist, in St. Petersburg, Florida.

At Thursday's close, the S&P 500 was down about 10 percent for the last 10 trading sessions.

Stocks had been lower for much of the day as worries about slower global growth remained firmly intact despite stronger-than-expected U.S. jobs data.

Intense recent selling -- taking both the Dow and the S&P 500 down 4 percent and the Nasdaq down 5 percent on Thursday -- reflects frustration with politicians' inability to address pressing concerns over high public debt in Europe and the United States as growth in the world's large industrial economies shows signs of stalling.

Slower growth in manufacturing and services in the United States also have renewed concern about another U.S. recession.

Among the day's best-performing sectors were defensive ones: consumer staples and health care. The S&P consumer staples index was up 2 percent.

The Dow Jones industrial average was up 132.33 points, or 1.16 percent, at 11,516.01. The Standard & Poor's 500 Index was up 11.07 points, or 0.92 percent, at 1,211.14. The Nasdaq Composite Index was up 4.86 points, or 0.19 percent, at 2,561.25.

U.S. non-farm payrolls data showed a gain of 117,000 jobs in July compared with a forecast for an increase of 85,000, while the country's unemployment rate dipped to 9.1 percent last month from 9.2 percent in June, the Labor Department reported.

Also affecting stocks was talk of a possible S&P downgrade of U.S. debt after the close.

The recent steep sell-off has put all three major indexes in negative territory for the year.

Credit Suisse on Friday reduced its year-end view on the S&P 500 to 1,350 from 1,450, citing weaker-than-expected growth.

Other strategists saw the bearish mood as more temporary.

"If this is a market reaction to a crisis, then a bounce should be under way soon. Since WWII, there are only three instances where U.S. stocks fell 10 percent in 10 days outside of recessions," according to JPMorgan Chase strategist Thomas Lee, in a research note.

Reflecting the market's volatility, the CBOE Volatility Index or VIX whipped between positive and negative in early afternoon trading. It was last up 0.2 percent at 31.71, after earlier touching an intraday high at 39.25, its highest level since May 2010.

ECB eyes decision on Italy bond buys to ease debt

(Reuters) - The European Central Bank will decide later on Sunday whether to buy Italian bonds to try and prevent the euro zone debt crisis from widening, while global policymakers conferred on the twin financial crises in Europe and the United States.

After a week that saw $2.5 trillion wiped off world stock markets, political leaders are under searing pressure to reassure investors that Western governments have both the will and ability to reduce their huge and growing public debt loads.

ECB President Jean-Claude Trichet wants the policy-setting Governing Council to take a final decision on buying Italian paper after Prime Minister Silvio Berlusconi announced new measures on Friday to speed up deficit reduction and hasten economic reforms, one ECB source said.

The source said that if the ECB council opted to intervene on Italy at a crucial conference call starting at 1700 GMT (1 p.m. EDT), the ECB and national central banks would start buying Italian bonds when markets open on Monday.

That would likely prompt a sizeable relief rally on global markets. If it does not act, the reverse would be true.

Another source said the council would look too at possible emergency liquidity measures to prevent money markets freezing. The fourth anniversary of the global credit crunch which ushered in the financial crisis looms this week.

A third ECB source said the teleconference had been put back into the evening to see what measures the United States was ready to take to calm markets after credit ratings agency Standard & Poor's downgraded Washington's AAA rating to AA+.

The ECB reactivated its sovereign bond-buying program last Thursday but purchased only small quantities of Irish and Portuguese bonds, seeking tougher austerity measures from Italy. That did nothing to stem market attacks on Italian assets.

Berlusconi's plans entail moving up a balancing of the budget by one year to 2013, enshrining a balanced budget rule in the constitution and pushing through welfare and labor market reforms after talks with trade unions and employers.

He gave little detail about how that would be achieved and the measures will take some time to enact.

The debt crises on either side of the Atlantic, with the latest shock coming from Friday's U.S. downgrade, are whipping up market turmoil and stoking fears of the affluent world sliding back into recession.

Markets in the Gulf region and in Israel, among the first to trade since the U.S. credit downgrading, tumbled on Sunday on worries the U.S. ratings downgrade and European debt woes may trigger another global downturn.

G-20, G-7 CRISIS CONTACTS

South Korea said finance deputies from the Group of 20 big economies addressed the European crisis and U.S. sovereign rating downgrade in an emergency conference call on Sunday morning Asian time.

A Japanese government source said finance leaders from the Group of Seven big developed economies would also discuss the crisis and might issue a statement afterwards. The timing of a planned conference call was unclear, but was likely to be held before Asian markets reopen on Monday.

French President Nicolas Sarkozy, who chairs the G7 and G20 forums this year, conferred with Britain's Prime Minister David Cameron on Saturday.

"Both agreed the importance of working together, monitoring the situation closely and keeping in contact over the coming days," a spokesman for Cameron said.

A White House economic adviser castigated ratings agency Standard and Poor's for cutting the U.S. credit rating to AA-plus from AAA. The U.S. Treasury said the rating agency's debt calculations were wrong by some $2 trillion.

Over time, S&P's move could ripple through markets by pushing up borrowing costs and making it more difficult to secure a lasting recovery.

S&P chief David Beers told "Fox News Sunday" that the Treasury Department's criticism of the credit rating agency's analysis was a "complete misrepresentation." Even with the debt limit agreement passed by the U.S. Congress, he said, "the underlying debt burden of the U.S. is rising and will continue to rise over the next decade."

Asked about prospects for a further lowering of the U.S. rating, Beers said the agency's negative outlook meant that "risks are on the downside."

ALARM IN GERMAN, FRENCH MEDIA

Newspapers in Germany, the euro zone's reluctant bankroller, were both incredulous and gloomy on Sunday about the financial upheaval.

Welt am Sonntag dedicated an entire section to global economic uncertainties, entitled "Der Crash" and wrote: "No one could have foreseen this dramatic crash and now the situation can only be endured with gallows humor."

Der Spiegel magazine's front page featured euro and dollar banknotes going up in flames, with the headline "U.S. indebtedness, euro crisis, stock market chaos: Is the world going bankrupt?"

French newspapers carried grim headlines with Le Journal du Dimanche trumpeting "The world on the edge of collapse" with a sub-headline saying: "The week starting should be crucial. Markets from now on are living in fear of a crash."

Washington's Asian allies rallied round the battered superpower, with Japan and South Korea both saying their trust in U.S. Treasuries remained unshaken and urging investors not to panic.

"I expressed our country's position on the (G20 conference) call that there will be no sudden change in our reserve management policy," South Korean Deputy Finance Minister Choi Jong-ku told Reuters by telephone, referring to Seoul's heavy ownership of U.S. bonds.

"There's no alternative that provides such stability and liquidity," added Choi.

The most immediate concern for financial markets was the debt crunch in the euro zone, where yields on Italian and Spanish debt have leaped to 14-year highs on political wrangling and doubts over the vigor of budget cuts.

"The ECB has got to confront the speculators who are out to test the policymakers," said Mike Lenhoff, chief strategist at Brewin Dolphin in London. "(The U.S. downgrade) might cause some upheaval temporarily. The big issue is the euro zone and its implications for the banking system."

SPLITS IN ECB

The ECB remains divided over whether to buy bonds at all, with four German, Dutch and Luxembourg members of the 23-member council opposed, ECB sources said. Even some of those in favor say Italy should do more to front-load its reforms.

The danger is that further pressure on Italian and Spanish bonds could further undermine a damaged European banking system and lock Italy, the world's No. 8 economy, out of the market.

Indeed, doubts are growing in the German government that Italy could be rescued by the European emergency fund, even if the fund were tripled in size, according to Der Spiegel.

Italy's financial needs are so huge that it would overwhelm resources, according to government experts, Der Spiegel said in its online edition. Italy's public debt is about 1.8 trillion euros, or 120 percent of its national output.

Germany has consistently said troubled euro-zone governments should focus on spending cuts and internal reforms, not bailouts. The European Financial Stability Fund currently has 440 billion euros and would need to be expanded to cater for the likes of Italy and Spain.

China, the largest foreign holder of U.S. debt, took the world's economic superpower to task for allowing its fiscal house to get into such disarray.

On Sunday, a commentary in the People's Daily, the main newspaper of the ruling Communist Party, said Asian exporters, who depend on demand from the United States, could be among the biggest victims of the mounting U.S. economic woes.

"The lowering of the United States' long-term sovereign credit rating has sounded a warning bell for the international currency system dominated by the U.S. dollar," said economist Sun Lijian, writing in the paper.

Dollar to drop on S&P, flows seen to safe assets

(Reuters) - The U.S. dollar is likely to take a further beating against the Swiss franc and Japanese yen on Monday, while global stocks could tumble after the United States lost its top-tier credit rating from Standard & Poor's.

Losses against the euro, however, could be tempered by the euro zone's escalating debt crisis as officials there discuss ways to reduce borrowing costs for large euro zone economies Spain and Italy.

The dollar's fall against the safe-haven Swiss franc and yen could be limited by possible intervention by the Bank of Japan and Swiss National Bank to stem their surging currencies.

Stocks in Tel Aviv, one of the first global equity markets to open since the downgrade, dropped over 6 percent on Sunday in response to S&P's action late on Friday to cut the U.S. long-term credit rating by a notch to "AA-plus" from "AAA."

The move by S&P drew criticism from some of the world's largest investors.

"Obviously, we're going to get freaked out a little bit and the dollar will get hit, but it's only going to be for a couple of days," said John Taylor, chairman and chief executive officer of FX Concepts, the world's largest currency hedge fund.

Over the past month, the dollar shed 6 percent against the Swiss franc and about 4 percent against the yen.

"This downgrade is not that important and if you ask me, too silly. The U.S. is in a much better position than any, I repeat, any European country," Taylor added.

It was not yet clear whether European policymakers would be able to come up with measures to allay concerns about their own region's fiscal crisis, though all the signs were that they were keenly aware of the importance of reassuring markets.

Sources said the European Central Bank will hold a conference call at 1700 GMT to decide whether to buy Italian government bonds in the secondary market.

One ECB source said that if the ECB council opted to intervene on Italy, the ECB and national central banks would start buying Italian bonds when markets open on Monday.

The ECB last week resumed its purchases of government bonds in the secondary market after an 18-week hiatus, but its decision to restrict such purchases to Irish and Portuguese bonds led to sharp declines in Italian and Spanish bond prices, and borrowing costs soared to 14-year highs.

"There is no reason why the ECB cannot simply go ahead and imply that they are going to support the Italians and the Spanish," said Mike Lenhoff, chief strategist at Brewin Dolphin in London. "It is better that they don't say anything, but go in and show there is another side to the market."

Any ECB buying would offer relief to beaten-down Italian and Spanish bonds, although the extent of any rally in these bonds will depend on the size and persistence of the bank's bond purchases.

U.S. RECESSION FEARS

Worries of another U.S. recession and concern about the euro zone crisis have sparked a global stock market slump that wiped $2.5 trillion off companies' values in the past week.

The fall in global share prices, as measured by the MSCI All-Country World Index, was the biggest weekly decline since early October 2008, according to Thomson Reuters Datastream.

Consumer discretionary shares of firms dependent on external demand are likely to be singled out for more punishment.

Still, some investors believed the expected sell-off in stocks on the U.S. credit downgrade had been largely priced in and may not last long. Some expressed doubts about the S&P decision as they are well aware of questions on the S&P's calculations of the projected U.S. fiscal deficits.

"The U.S. track record -- over the past 200 years -- on its ability and willingness to fully service its debt is impeccable and the debt statistics should be interpreted not in isolation but in conjunction with the flawless track record of the U.S.," said Stephen Jen, managing director of SLJ Macro Partners in London, a global macro hedge fund.

"This will have no lasting effects on financial asset prices," he added.

U.S. Treasury debt yields are also expected to rise on Monday. Yields on benchmark U.S. 10-year Treasury notes rebounded to 2.56 percent on Friday, but were not very far from a record low of near 2 percent hit during the throes of the 2007-09 global financial crisis.

The sharp swings in financial markets have piled pressure on policymakers.

Finance ministers from the Group of Seven most developed economies are on Monday to discuss the U.S. sovereign rating downgrade and Europe's debt woes, Japanese news agency Kyodo reported on Sunday.

"Be wary (Monday) of irrational depression as markets take flight," said Justin Urquhart Stewart, a director at Seven Investment Management in London. "We are dealing with the knowns and not the unknowns, but what we have a shortage of at the moment is political leadership."

Goldman Sachs strategists said there was a one-in-three probability of a U.S. recession due to the worsening European crisis, the possible failure to extend payroll tax cuts and elevated levels of joblessness, despite a slight dip in the U.S. unemployment rate in July.

That would bode ill for the benchmark MSCI all-country index, which last week hit its lowest since September 2010 and has accumulated losses of more than 12 percent since late July.

"Market sentiment appears acutely vulnerable given the build-up of concern on a sharper U.S. slowdown and speculation on the appropriate policy response and lingering fears stemming from the sovereign debt crisis in Europe," Citigroup strategists said in a note.

ECB to intervene decisively on markets: source

(Reuters) - The Euro system of central banks has decided to intervene decisively on markets to respond to the escalating debt crisis, a euro zone monetary source said after a European Central Bank conference call on Sunday.

Officials on the conference call carefully considered the situation in Italy and Spain, and took note of a statement by France and Germany which stressed their commitment to European financial reforms, the source said.

"The Euro system will intervene very significantly on markets and respond in a significant and cohesive way," the euro zone monetary source said, adding a statement by the ECB will be issued shortly.

G7 gives first sign ready to battle crisis

(Reuters) - Political and financial leaders gave their first sign of readiness to battle a debt crisis gone global when the European Central Bank signaled on Sunday it would start buying Italian and Spanish debt, a critical move to quell a bond rout that has rocked financial markets.

The European Central Bank decision would be aimed at calming markets grown increasingly doubtful about Europe's ability to deal with its debt issues, a strikingly parallel concern to that which led ratings agency Standard & Poor's to knock U.S. debt down from "risk free" AAA status to AA-plus.

Meanwhile, finance chiefs from Group of Seven industrial nations were to confer by telephone late on Sunday-- and possibly issue a statement afterward -- to try to soothe anxious investors after a week in which $2.5 trillion of market value was wiped out.

Any statement would be timed to precede the opening of trading in Tokyo, the first major market to open on Monday, at 9 a.m. local time (0000 GMT/8:00 p.m. EDT Sunday).

ECB President Jean-Claude Trichet said in a statement after discussions with his Governing Council on Sunday that the central bank welcomes new steps taken by Italy and Spain on fiscal and structural reforms, and hence it would "actively implement" its bond-buying program. A monetary source said this means it is ready to start buying up the debt of these two countries.

"The Euro system will intervene very significantly on markets and respond in a significant and cohesive way," the source said.

Political leaders are under searing pressure to reassure investors that Western governments have both the will and ability to reduce their huge and growing public debt loads.

ECB President Jean-Claude Trichet wanted the policy-setting Governing Council to take a final decision on buying Italian paper after Prime Minister Silvio Berlusconi announced new measures on Friday to speed up deficit reduction and hasten economic reforms, one ECB source said.

LOOKING FOR A BOUNCE

Buying Italian bonds would likely prompt a sizable relief rally on global markets.

On Sunday afternoon, German Chancellor Angela Merkel and French President Nichola Sarkozy weighed in with a joint statement praising both Italy and Spain for their pledges to impose budget austerity.

They stressed that "complete and speedy implementation of the announced measures is key to restor(ing) market confidence."

The back-and-forth between Standard & Poor's and the Obama administration over whether the downgrade of Washington's rating was justified continued on U.S. Sunday-morning talk shows where a senior official from the ratings agency said its concerns about political impasse in Washington were valid.

John Chambers, an S&P managing director, said on ABC's "This Week" that years may be needed to regain AAA status and even them "it would take, I think, more ability to reach consensus in Washington than what we're observing now."

White House economic adviser Gene Sperling blasted the S&P ruling on Saturday night, saying it "smacked of an institution starting with a conclusion and shaping any arguments to fit it."

U.S. Treasury Secretary Timothy Geithner, who had indicated he might leave the administration once an increase in the debt ceiling was agreed, announced on Sunday that he was not doing so and would stay on.

That relieves President Barack Obama of the difficult prospect of finding a replacement who could win Senate confirmation in Washington's bitterly partisan atmosphere.

Treasury says that S&P's debt calculations were off by $2 trillion but the agency said that did not change the fact that the United States' longer-term debt prospects were worsening.

Twin debt crises in the United States and Europe had policy makers scrambling to keep financial markets from panic.

The ECB reactivated its sovereign bond-buying program on Thursday but purchased only small quantities of Irish and Portuguese bonds, seeking tougher austerity measures from Italy. That did nothing to stem market attacks on Italian assets.

Berlusconi's plans entail moving up a balancing of the budget by one year to 2013, enshrining a balanced budget rule in the constitution and pushing through welfare and labor market reforms after talks with trade unions and employers.

He gave little detail about how that would be achieved and the measures will take some time to enact.

G-20, G-7 CRISIS CONTACTS

South Korea said finance deputies from the Group of 20 big economies addressed the European crisis and U.S. sovereign rating downgrade in an emergency conference call on Sunday morning Asian time.

French President Nicolas Sarkozy, who chairs the G7 and G20 forums this year, conferred with Britain's Prime Minister David Cameron on Saturday.

"Both agreed the importance of working together, monitoring the situation closely and keeping in contact over the coming days," a spokesman for Cameron said.

Over time, S&P's move could ripple through markets by pushing up borrowing costs and making it more difficult to secure a lasting recovery.

S&P chief David Beers told "Fox News Sunday" that the Treasury Department's criticism of the credit rating agency's analysis was a "complete misrepresentation." Even with the debt limit agreement passed by the U.S. Congress, he said, "the underlying debt burden of the U.S. is rising and will continue to rise over the next decade."

Asked about prospects for a further lowering of the U.S. rating, Beers said the agency's negative outlook meant that "risks are on the downside."

ALARM IN GERMAN, FRENCH MEDIA

Newspapers in Germany, the euro zone's reluctant bankroller, were both incredulous and gloomy on Sunday about the financial upheaval.

Welt am Sonntag dedicated an entire section to global economic uncertainties, entitled "Der Crash" and wrote: "No one could have foreseen this dramatic crash and now the situation can only be endured with gallows humor."

French newspapers carried grim headlines with Le Journal du Dimanche trumpeting "The world on the edge of collapse" with a sub-headline saying: "The week starting should be crucial. Markets from now on are living in fear of a crash."

Washington's Asian allies rallied round the battered superpower, with Japan and South Korea both saying their trust in U.S. Treasuries remained unshaken and urging investors not to panic.

"I expressed our country's position on the (G20 conference) call that there will be no sudden change in our reserve management policy," South Korean Deputy Finance Minister Choi Jong-ku told Reuters by telephone, referring to Seoul's heavy ownership of U.S. bonds.

"There's no alternative that provides such stability and liquidity," added Choi.

SPLITS IN ECB

In some quarters including in the German government, there are doubts that Italy can be rescued by the European emergency fund, even if the fund were tripled in size, according to newsmagazine Der Spiegel.

Italy's financial needs are so huge that it would overwhelm resources, according to government experts, Der Spiegel said in its online edition. Italy's public debt is about 1.8 trillion euros, or 120 percent of its national output.

Germany has consistently said troubled euro-zone governments should focus on spending cuts and internal reforms, not bailouts. The European Financial Stability Fund currently has 440 billion euros ($632.5 billion) and would need to be expanded to cater for the likes of Italy and Spain.

China, the largest foreign holder of U.S. debt, took the world's economic superpower to task for allowing its fiscal house to get into such disarray.

On Sunday, a commentary in the People's Daily, the main newspaper of the ruling Communist Party, said Asian exporters, who depend on demand from the United States, could be among the biggest victims of the mounting U.S. economic woes.

"The lowering of the United States' long-term sovereign credit rating has sounded a warning bell for the international currency system dominated by the U.S. dollar," said economist Sun Lijian, writing in the paper.

ECB buying steadies Europe, U.S. downgrade weighs

(Reuters) - Italy and Spain's borrowing costs fell on Monday as reports filtered in that the European Central Bank was buying their bonds, lifting European shares and partly overcoming jitters about a rating downgrade for U.S. debt.

Five-year yields in Italy and Spain fell more than 80 basis points. Spreads with German debt narrowed and the cost of insuring against default dropped.

Gold nonetheless soared to a new record above $1,700 an ounce on safe-haven buying and the dollar weakened against a basket of major currencies.

Investors were digesting a weekend of talks between industrialized countries aimed at ensuring the smooth functioning of financial markets following agency S&P's cut in its U.S. rating late on Friday to AA-plus from AAA.

Focusing on the euro zone crisis, the ECB agreed to intervene in the Italian and Spanish debt markets to reduce borrowing costs that are close to prohibitive.

"The downgrade to the U.S. is not great. These markets are going to remain unsettled for a while, we had recommended investors to raise cash in anticipation of this volatility," said Mike Lenhoff, chief strategist at wealth manager Brewin Dolphin.

"If the ECB is going to provide some support to the bond markets that could create some sort of relief, buying opportunities could emerge in the sold off cyclical areas, but we are looking for more stability first."

MSCI's all-country world index was down slightly, recovering as Europe gained. Last week's heavy bout of risk aversion chopped around $2.5 trillion off the value of the index.

Emerging market stocks were still being hit, losing around 2 percent on Monday.

European shares, as measured by the FTSEUrofirst 300 index shrugged off opening losses and moved into positive territory, rising a quarter of a percent as news filtered in that the ECB was buying Italian and Spanish bonds.

EASING PAIN

The ECB moves followed criticism last week that the bank had not addressed pressure on Spain and Italy when they bought Portuguese and Irish debt last week.

Traders said Monday's buying was focused on the 5-year sector of the curve, where Italian yields dropped to around 4.6 percent, while the Spanish equivalent was around 4.5 percent.

"They're doing 20 to 25 million (euro) clips and they're spreading it around the market," said a trader. "We expect them to do billions today."

The euro rose against the dollar and trimmed losses against other currencies.

The U.S. currency fell across the board after the S&P downgrade, struggling around record lows against the Swiss franc and the yen.

But the euro's gains were limited, and some analysts expected it would struggle to gain significantly, as bond purchases, while adding temporary liquidity to stressed bond markets, would do little to improve the fiscal problems in the region.

"(ECB bond buying) will have a short term effect. It won't have any lasting positive impact on the euro," said Richard Falkenhall, currency strategist at SEB in Stockholm.

"Even if the ECB buys Italian bonds, private investors will just sell and off-load their Italian risk ... The ECB will have to buy those bonds constantly just to keep yields stable," he said.

Oil falls more than 3 percent after U.S. downgrade

(Reuters) - Oil dropped more than 3 percent on Monday, as worry about an economic slowdown spread after Standard & Poor's cut the United States' top-tier credit rating late on Friday.

Fear gripped financial markets as the fallout from the historic downgrade of the U.S. debt rating by S&P drowned out pledges of assistance from Europe's central bank and soothing words from the Group of Seven.

U.S. stocks tumbled early, tracking a sharp drop in global equity markets following S&P's move. .N

Brent crude fell $3.60 to $105.77 a barrel by 10:34 a.m. EDT, after earlier falling as low as $105.45. U.S. crude fell $3.42 to $83.46 after sliding to its lowest intraday level since November at $82.52 a barrel in early trade.

"In the tumultuous aftermath of the U.S. downgrade from S&P, the world also is downgrading the oil market," said Phil Flynn, analyst at PFGBest Research in Chicago.

Goldman Sachs said on Monday it maintained overweight recommendation on commodities and oil relative to other assets, although it added that risk to its constructive commodity views had risen.

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