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Euro, Stocks Retreat as ECB’s Balance Sheet Expands to Record Amid Crisis

The euro slid to a 10-year low versus the yen and stocks fell, halting a five-day rally in the Standard & Poor’s 500 Index, as Italian bonds erased earlier gains and a surge in the European Central Bank’s balance sheet to a record highlighted risks from the region’s debt crisis.

The euro lost as much as 1.1 percent to 100.73 yen and decreased 1 percent to an 11-month low of $1.2937. The S&P 500 dropped 1.3 percent to 1,249.64 at 4 p.m. in New York and the Dow Jones Industrial Average lost 139.94 points, or 1.1 percent, to 12,151.41. Ten-year Italian bond yields rose less than one basis point to 6.999 percent after losing as much as 25 basis points. Oil snapped a six-day advance and gold capped the longest slump in two years. U.S. Treasuries rallied.

The ECB’s balance sheet soared to a record 2.73 trillion euros ($3.55 trillion) after it lent financial institutions more money last week in an attempt to keep credit flowing to the economy during the debt crisis. Early gains in stocks and U.S. index futures came after Italy’s borrowing costs plunged at an auction of 9 billion euros of six-month bills, while investors turned their attention to the nation’s auction of longer-term bonds tomorrow.

“If the euro zone banks are too afraid to lend, that does not bode well for future growth in the region,” Brian Jacobsen, who helps oversee about $209 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin, said in a telephone interview. “The banks are not borrowing from the ECB in order to spur lending. It’s to shore up their own balance sheets. That could lead to a credit contraction in the euro zone.”

ECB Loans

The ECB last week awarded 523 banks three-year loans totaling a record 489 billion euros to encourage lending. So far, banks are parking the money back at the ECB. Overnight deposits at the central bank increased to an all-time high of 452 billion euros yesterday.

The euro weakened against all 16 of its major peers except for the British pound and Danish krone. The pound decreased against all 16 peers, while the dollar strengthened against 13 of 16.

The S&P 500 retreated after rising for a fifth straight (SPX) day yesterday, matching its longest streak of gains of the year. Commodity and energy producers and financial companies led losses in all 10 of the main industry groups in the benchmark index today. Caterpillar Inc., Chevron Corp. and 3M Co. fell more than 1 percent to lead declines in all 30 stocks in the Dow.

Year in Stocks

With two more trading days left in 2011, the S&P 500 would need to rise 2.6 percent to reach the year-end forecast of Wall Street strategists. Their mean estimate of 1,282 is lower than the 1,371 predicted in January, according to data compiled by Bloomberg. Today’s decline sent the S&P 500 down 0.6 percent for the year. Still, a 10.5 percent rally since the end of September put the gauge on pace for the best fourth-quarter since 2003.

Treasury 10-year yields slipped eight basis points to 1.92 percent, while the 10-year German bund yield was three basis points lower at 1.89 percent.

Oil in New York dropped 2 percent to $99.36 a barrel, the first decline in seven sessions.

Crude climbed as high as $101.71 earlier amid concern Iran will block the Strait of Hormuz, through which passes about 15.5 million barrels of oil a day, a sixth of global consumption. The U.S. won’t tolerate a disruption to shipping in the strait, Navy spokeswoman Rebecca Rebarich said in an e-mail. Gulf Arab countries are prepared to make up for any loss of Iranian oil from the world market, the Associated Press reported, citing an unidentified Saudi Arabian oil official.

Gold Retreats

Gold for February delivery declined 2 percent to settle at $1,564.10 an ounce, a fifth straight drop. Cotton trimmed gains after jumping the exchange limit 4 cents, or 4.6 percent, to 91.91 cents in New York as sales dropped by farmers in India, the world’s second-largest grower.

Germany’s DAX Index (DAX) lost 2 percent to lead declines among major European markets. The FTSE 100 Index slipped 0.1 percent today in the U.K., where financial markets were shut the previous two days for holidays.

The Stoxx Europe 600 Index fell 0.7 percent today and has dropped 13 percent this year, compared with an 18 percent slump in the MSCI Asia-Pacific Index and a loss of 0.6 percent in the S&P 500, which has fluctuated above and below its 2010 closing level since the end of October.

Today’s decline brought the S&P 500 back below its average price over the past 200 days after it climbed above the trend line in the previous two sessions. The Dow is up 5 percent in 2011.

Italian Debt

Two-year Italian yields slipped seven basis points to 5.00 percent today.

Italy sold 179-day bills today at a rate of 3.251 percent, down from 6.504 percent at the last auction on Nov. 25. Demand was 1.7 times the amount offered, compared with 1.47 times last month. Italy will seek to sell bonds maturing in 2014, 2018, 2021 and 2022 tomorrow. The nation’s 10-year bond yields climbed to 7 percent yesterday, the level that foreshadowed bailouts for Greece, Ireland and Portugal. A report tomorrow may show Italian business confidence dipped to the lowest in almost two years.

The MSCI Emerging Markets Index dropped 1.3 percent, its biggest decline since Dec. 19. South Korea’s Kospi index fell 0.9 percent, down for a third day. India’s Sensex (SENSEX) decreased 0.9 percent before a report this week that may show the nation’s current-account deficit widened to a record. Hungary’s BUX Index retreated 1 percent, Poland’s WIG20 decreased 1.2 percent and Turkey’s ISE National 100 Index slipped 1.9 percent.

The MSCI Asia-Pacific retreated 0.8 percent today.

Japan’s industrial output slumped 2.6 percent in November from October, more than all the forecasts in a Bloomberg survey of 29 economists. The Bank of Korea said an index of manufacturers’ expectations for January was 79, the lowest since July 2009. Thailand’s industrial output sank the most in more than a decade in November, government data showed.

To contact the reporters on this story: Michael P. Regan in New York at mregan12@bloomberg.net; Rita Nazareth in Sao Paulo at rnazareth@bloomberg.net

To contact the editor responsible for this story: Michael P. Regan at mregan12@bloomberg.net

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