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Stocks fall, yields rise as central banks rattle markets

Traders work on the floor of the NYSE in New York

By Herbert Lash and Marc Jones

NEW YORK/LONDON (Reuters) - World stocks fell for a fifth straight session and the dollar hit its strongest since March on Thursday as Treasury yields rose to levels last seen during the 2008 global financial crisis after the Federal Reserve warned rates will stay higher for longer.

The U.S. central bank on Wednesday kept its key lending rate steady, as expected, but indicated another hike is possible as it and other central banks tighten policy to tame inflation.

The British pound and the Swiss franc tumbled after the Bank of England and Swiss National Bank refrained from raising rates, both surprise moves, but the central banks of Norway and Sweden each hiked by a quarter percentage point as expected.

Major equity indices in Europe and on Wall Street fell more than 1% on concerns higher rates will curb growth. The question is whether the market shrugs off high rates as in the past on expectations the Fed cuts them to counter a slowdown.

"For the last year there's been a gap for this hopeful optimism by investors that the Fed is near done or we'll be done and the Fed continues to suggest we're not so sure," said Michael Arone, chief investment strategist at State Street Global Advisors in Boston.

"You are seeing some subtle shifts in both stocks and in the bond markets to reflect higher for longer, to reflect the uncertainty that the Fed is in fact nearing the end of its tightening cycle," he said.

Futures pared back expectations that the Fed's target rate will stay above 5% through late July 2024 from September next year, as indicated on Wednesday. But futures also reduced the likelihood of deeper rate cuts the market had expected.

U.S. rates moved higher. The two-year Treasury yield, which reflects interest rate expectations, rose 2 basis points to 5.140%, while the benchmark 10-year note surged more than 13 basis points to 4.492%, the highest since November 2007.

The Fed's upgrading of its growth expectations for 2024 to about 1.5% from a 1.1% forecast in June suggests that despite higher rates, the economy will be OK, said Jack Ablin, chief investment officer at Cresset Capital Management LLC in Pebble Beach, Florida.

"It's just a steady headwind that we face, it's not a crisis. I don't see it as any marked change in how we need to view things," he said. "But these financing costs are going to hurt."

Saxo Bank analyst John Hardy said Europe's central bank moves showed there was now more uncertainty about both when and where interest rates max out.

"Different countries are in different gears so it is real data-driven responses we are seeing now, especially for the UK," Hardy said after the BoE's pause, its first pause after 14 consecutive hikes.

"It punctures the balloon on terminal rates and also creates more second guessing on the quality of the (economic) landings."

MSCI's gauge of stocks across the globe shed 1.70%, marking a fifth day in the red and its longest losing streak since March. The pan-European STOXX 600 index lost 1.30%.

U.S. stocks also slumped. The Dow Jones Industrial Average fell 1.08%, the S&P 500 lost 1.64% and the Nasdaq Composite dropped 1.82%.

The dollar index, which measures the U.S. currency against a basket of currencies, rose as high as 105.74, its strongest since March 8, pushing the yen close to its weakest since November.

The dollar index later eased, down 0.047% at 105.35, with the euro down 0.01% to $1.0658.

Sterling, which has been on the slide since July, dropped through $1.23 to as low as $1.223. [/FRX]

Mirroring a rise in Treasury yields, Germany's 10-year government bond yield touched a fresh six-month high of 2.73% and Britain's 10-year gilt yield rose to 4.29% after falling on Wednesday to its lowest since July. [GVD/EUR]

Oil prices settled lower in choppy trading, rising as much as $1 a barrel after a Russian ban on fuel exports snatched the focus from Western economic headwinds that had pushed prices down $1 a barrel early in the session.

Brent futures settled down 23 cents to $93.30 a barrel, while U.S. West Texas Intermediate fell 3 cents to settle at $89.63.

Gold extended its decline for a third straight day as the dollar and Treasury yields rallied on the Fed's warning of a possible additional rate hike.

U.S. gold futures settled 1.4% lower at $1,939.60 an ounce.

(Additional reporting by Xie Yu in Hong Kong; Editing by Marguerita Choy, Tomasz Janowski and Deepa Babington)