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Dollar, stocks rally as Bernanke calms markets

Signs that investors still fear the impact of a lingering credit crunch could be seen in Europe, where stocks fell and euro zone government bonds advanced amid worries about further potential write-downs by banks.

Trading started on a weaker note on Wall Street as a sharper-than-expected decline in pending U.S. home sales in May signaled more trouble for the beleaguered housing market and supported a rise in fixed-income markets.

But Bernanke bolstered the market with a speech saying that the U.S. central bank may extend emergency lending facilities for big Wall Street banks past year-end as it seeks to restore financial market stability.

"What Bernanke's saying is helping Wall Street, and that's helping the dollar," said Boris Schlossberg, senior currency strategist at DailyFX.com in New York. "Everybody thinks the Fed's No. 1 mandate is to fight inflation, but it's actually to make sure the banks are solid.

"What they're trying to do is avoid a panic on Wall Street, and in the near term that's dollar-positive," he added.

Bernanke's comments stopped a sell-off in financial stocks on Monday when Lehman Brothers estimated a proposed accounting rule could force Fannie Mae FNM.N and Freddie Mac FRE.N billions in fresh capital. Some thought the market reaction was overdone since Lehman said itself said it doubted an accounting change detrimental to the two largest U.S. mortgage lenders would be enacted.

The S&P financial index .GSPF rose more than 2 percent.

Also lifting U.S. shares was a rally in defensive stocks such as pharmaceutical shares, with the American Stock Exchange .DRG index of 14 big Pharma companies up 2.7 percent.

Before 1 p.m., the Dow Jones industrial average .DJI rose 47.54 points, or 0.42 percent, at 11,279.50. The Standard & Poor's 500 Index .SPX was up 4.12 points, or 0.33 percent, at 1,256.43. The Nasdaq Composite Index .IXIC was up 17.26 points, or 0.77 percent, at 2,260.58.

In Europe, fresh concern about the outlook for the banking sector drove shares down. A steep drop in crude prices and a rally in safe-haven sectors such as drugmakers helped stem the slide.

Some analysts believe there may be some respite to the selling in the European equity market, which has fallen by about 30 percent since last July's multi-year highs.

"We're probably close to a bottom, but not the bottom. We're so bombed out, so oversold that we could gradually work our way slightly higher. This is not a good moment to sell," said Philippe Gijsels, a European equities strategist at Fortis Bank in Brussels.

The FTSEurofirst 300 index .FTEU3 of top European shares ended the day down 1.47 percent at 1,161.38 points, but well off session lows.

Oil tumbled to as low as $136 a barrel as the dollar gained and concern eased over an Atlantic hurricane.

U.S. light sweet crude oil CLc1 fell $4.77 to $136.60 per barrel.

Spot gold prices XAU fell $3.20 to $922.25.

Hurricane Bertha became a "major" hurricane on Monday, but none of the computer models used to track storms indicated it would head for the Gulf, the center of the U.S. oil and gas industry.

Gold pulled further off a 2-1/2 month high set late last week as crude oil prices fell and the dollar's advance undermined both commodities.

The dollar rebounded on Bernanke's comments.

The dollar rose against major currencies, with the U.S. Dollar Index .DXY up 0.42 percent at 73.004. Against the yen, the dollar JPY was up 0.22 percent at 107.38.

The euro EUR fell 0.41 percent at $1.5657.

Asian stocks fell sharply overnight on jitters caused by the big declines in Fannie Mae and Freddie Mac.

Japan's Nikkei share average .N225 fell 2.45 percent to a three-month closing low.

Shares of companies in the Asia-Pacific region .MSCIAPJ were down 2.4 percent, according to an MSCI index. The all-countries world index .MIWD0000PUS slipped to the lowest since January 22.