Aug. 17 (Bloomberg) -- The biggest rally in four years for the Standard & Poor's 500 Index helped the U.S. stock market wipe out most of the week's losses after the Federal Reserve reduced the discount loan rate.

Merrill Lynch & Co., JPMorgan Chase & Co. and Lehman Brothers Holdings Inc. led financial shares to their steepest two-day rally since 2002. Exxon Mobil Corp., the largest oil company, gained the most in five years on speculation energy demand will increase in an expanding economy.

``It's just a brilliant move in letting the markets know where liquidity can be found and at what cost,'' said Tim Hartzell, who helps manage about $2 billion as chief market strategist at Kanaly Trust Co. in Houston. ``It brings the banks back to the table.''

The S&P 500 climbed 34.67, or 2.5 percent, to 1,445.94, paring its loss for the week to 0.5 percent. The Dow Jones Industrial Average increased 233.3, or 1.8 percent, to 13,079.08. The Nasdaq Composite Index rose 53.96, or 2.2 percent, to 2,505.03.

Europe's Dow Jones Stoxx 600 Index rallied 2.2 percent to 359.98 after falling as much as 1 percent earlier, helped by Fed Chairman Ben S. Bernanke's first acknowledgement that a policy shift is needed to contain the subprime-mortgage collapse.

``Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward,'' the Federal Open Market Committee said in a statement following an unscheduled meeting. ``The downside risks have increased appreciably.''

Financials Rally

Financial stocks in the S&P 500, the year's second worst- performing group, rose 3.6 percent. Merrill Lynch gained $4.91 to $76.04. JPMorgan advanced $1.54 to $47.01. Lehman added $3.36 to $58.11. Two-year Treasury notes increased, pushing the yield down 6 basis points, or 0.06 percentage point, to 4.17 percent.

The S&P 500 Thrifts & Mortgage Finance Index added 5 percent, led by Countrywide Financial Corp., which increased $2.48, or 13 percent, to $21.43, the most in seven years.

The biggest U.S. mortgage lender was upgraded to ``neutral'' from ``sell'' at Banc of America Securities LLC. Analysts including Robert Lacoursiere said the possibility of a ``liquidity-induced distressed sale'' is unlikely.

The other nine S&P 500 industries also rose, led by energy, utility and industrial shares, as investors speculated the economy's expansion is intact. All 32 companies in the S&P 500 Energy Index climbed. Exxon Mobil rose $3.47, or 4.3 percent, to $84.14. ConocoPhillips, the second-largest U.S. refiner, advanced $1.85 to $79.13.

Half-Point Cut

The FOMC reduced the interest rate it charges banks to 5.75 percent, the first time it has cut borrowing costs between scheduled meetings since 2001. Policy makers left the overnight federal funds target rate unchanged at 5.25 percent.

The S&P 500 tumbled 9.1 percent through yesterday from a July 19 record amid concern defaults on subprime home loans will hurt bank earnings and spur an increase in borrowing costs as investors shun riskier debt. The Dow average was down 8.3 percent from its peak.

``It shows a lot of creativity on Bernanke's part. He has a lot more options than people think,'' said Bartley Barnett, head of listed trading at Morgan Keegan Inc. in Memphis, Tennessee. ``It shows the Fed is being supportive and paying attention.''

Fed Funds

The Fed's action bolstered speculation that the central bank will lower its benchmark federal funds lending rate on overnight loans at or before its next meeting on Sept. 18. Goldman Sachs & Co. predicted fed funds will fall to 4.75 percent this year.

``We still expect the credit restraint and the housing downturn to push the unemployment rate up by an amount that has generally coincided with monetary easing in the past,'' Goldman said in a research note.

Consumer confidence dropped to the lowest in a year, according to the Reuters/University of Michigan index. The gauge fell to 83.3 from 90.4 a month earlier. Economists forecast the confidence measure would fall to 88, based on the median estimate in a Bloomberg survey.

The main measure of U.S. stock volatility declined after reaching a four-year high yesterday. The Chicago Board Options Exchange Volatility Index, known as the VIX, slipped 2.7 percent to 29.99. Lower readings show traders expect smaller share-price swings in the next 30 days.

Trading in the U.S. was also increased by the expiration of options tied to indexes and individual stocks. Some 2.48 billion shares changed hands on the New York Stock Exchange, 41 percent more than the three-month average.

More than six stocks advanced for every one that declined on the New York Stock Exchange.

`Tarnished'

Some traders said the rate cut damaged the Fed chairman's reputation as an inflation hawk.

``Bernanke, whether he really wants to admit it or not, he backed down'' and boosted the stock market, said Michael Bugno, president of Chicago Futures Group. ``We here on the floor are trying to check his credibility. It definitely got a little bit tarnished today.''

Hewlett-Packard Co. gained $1.10 to $47.15. The world's largest personal-computer maker forecast profit for this quarter between 80 cents and 81 cents a share, exceeding the average estimate of 78 cents a share from analysts polled by Bloomberg.

Huntington Bancshares Inc. rose 75 cents to $18.13. Ohio's fourth-largest bank said its mortgage customers were making fewer late payments even as bankruptcies and foreclosures climbed in the Midwest. The bank also said it has no subprime loans, given to borrowers considered at the highest risk of default.

Dell, E*Trade

Dell Inc. gained 39 cents to $26.32. The second-largest personal-computer maker completed a yearlong investigation into accounting errors and admitted executives manipulated financial results to meet quarterly earnings goals. The company said it would restate results between fiscal 2003 and the first quarter of 2007.

E*Trade Financial Corp. rose 95 cents to $14.50. The brokerage said almost all of its mortgage-backed securities have the highest rating. The company's comments should give ``comfort to investors,'' Lehman Brothers analyst Roger Freeman wrote in a research note.

Research In Motion Ltd. gained $22.50 to $220.52. The maker of the BlackBerry e-mail phones will forecast third-quarter earnings that will ``blow away'' estimates, Herb Weiss, an analyst with American Technology Research, wrote in a note.

Whole Foods Market Inc. climbed $3.13 to $44.30. A judge ruled the natural-food grocer's purchase of rival Wild Oats Markets Inc. doesn't violate antitrust laws and can proceed. Wild Oats jumped $2.71, or 18 percent, to $17.92, the biggest increase since 2002.

The Russell 2000 Index, a benchmark for companies with a median market value of $639 million, gained 2.2 percent to 786.03. The Dow Jones Wilshire 5000 Index, the broadest measure of U.S. shares, rose the most since 2003, advancing 2.4 percent to 14,531.52.

Countrywide Financial Corp. (CFC US)
ConocoPhillips (COP US)
Dell Inc. (DELL US)
E*Trade Financial Corp. (ETFC US)
Exxon Mobil Corp. (XOM US)
Hewlett-Packard Co. (HPQ US)
Huntington Bancshares Inc. (HBAN US)
JPMorgan Chase & Co. (JPM US)
Lehman Brothers Holdings Inc. (LEH US)
Merrill Lynch & Co. (MER US)
Research In Motion Ltd. (RIMM US)
Whole Foods Market Inc. (WFMI US)

To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net.

Last Updated: August 17, 2007 17:36 EDT