US STOCKS-Market falls on inflation jitters, oil's surge

(Updates to early afternoon, changes byline)

* Oil extends rise after crude, gasoline inventories fall

* Fed warns of higher inflation, unemployment

* Airline stocks fall sharply

By Kristina Cooke

NEW YORK, May 21 (Reuters) - U.S. stocks fell on Wednesday as record crude oil prices and comments from the Federal Reserve fueled concerns about inflation and cutbacks in non-essential consumer spending.

The Federal Reserve warned of higher inflation and unemployment and lowered its economic growth forecast for 2008. The U.S. central bank also signaled it was unlikely to cut interest rates again.

Further adding to oil-related jitters were comments from airplane maker Boeing's (BA.N) chief executive that he was concerned record oil prices are crimping airlines' growth.

Shares of Boeing fell 3.6 percent to $82.02 and were the biggest drag on the Dow Jones industrials. The comments came hours after AMR Corp's (AMR.N) American Airlines announced it would slash domestic capacity in the face of soaring fuel prices.

An index of airline stocks .XAL slid 10.9 percent. Apart from airlines, retailers, home builders and financial services stocks also lost ground.

Oil futures CLc1 in New York broke through $133 a barrel on Wednesday, after a U.S. government report showing a surprise drop in crude stockpiles reinvigorated fears of a worsening supply crunch.

"The market is starting to decide that at some point higher oil is going to be an economic drag. Given the fact that inflation ripples through the economy slowly the market is right to have that concern," said Chip Hanlon, president of Delta Global Advisors, Inc, in Huntington Beach, California.

The Dow Jones industrial average .DJI slid 210.55 points, or 1.64 percent, to 12,618.13, while the Standard & Poor's 500 Index .SPX fell 18.78 points, or 1.33 percent, to 1,394.62. The Nasdaq Composite Index .IXIC was down 40.14 points, or 1.61 percent, at 2,452.12.

Among major U.S. airlines, shares of Continental Airlines (CAL.N) dropped 12.97 percent to $14.20 after a brokerage downgraded the U.S. airline sector. AMR shares fell more than 25.5 percent to $6.11 on the NYSE.

Shares of energy companies, which benefit from higher oil prices, were a bright spot for indexes. Shares of Exxon Mobil (XOM.N) were up 0.7 percent to $95.22 before trading near flat and Chevron Corp (CVX.N) shares gained 0.3 percent to $103.42. The S&P index of energy shares .GSPE dipped 0.3 percent in the late afternoon after trading higher most of the session.

Shares of Moody's Corp (MCO.N) fell nearly 17 percent after it launched an investigation into a report that it had wrongly assigned triple-A ratings to complex European debt products. (Editing by Gary Crosse)