Global stocks weak, dollar tumbles on economy concerns

LONDON (Reuters) - Stocks fell and the dollar tumbled to historic lows on Friday as the Federal Reserve's warning on the health of domestic banks raised concerns over a U.S. recession, driving oil and safe-haven gold to record peaks.

Fed Chairman Ben Bernanke said on Thursday some small U.S. banks could fail during the current market turmoil stemming from the fallout in U.S. subprime mortgages, in remarks which fanned expectations for an aggressive interest rate cut in March.

However Bernanke also acknowledged inflation could complicate the central bank's effort to spur the economy, which weighed on risky assets.

"The market still looks very nervous. The banks are still the key talking point," said Keith Bowman, analyst at Hargreaves Lansdown.

"We've seen some ramification of (Bernanke's) comments in the continuing weakness of the dollar."

The FTSEurofirst 300 index was down 1.4 percent on the day, hitting a one-week low. The MSCI main world equity index fell 0.7 percent.

The dollar fell to a three-year low of 104.08 yen, hit record lows of $1.5238 per euro and tumbled to historic troughs against a basket of major currencies.

Interest rate futures markets are pricing in a 40 percent chance of the Fed lowering the cost of borrowing by three-quarters of a percentage point in March to 2.25 percent.

"Mr Bernanke identified the main economic risks as the credit crunch, employment and the housing market. Don't expect good news from any of these directions soon. The rise in inflation complicates the Fed's job. However, growth worries are in the driving seat," BNP Paribas said in a note to clients.

INFLATIONARY CYCLE

Gold XAU=, a safe-haven asset which offers an inflation hedge, rose as high as $975 an ounce, bringing gains this year to more than 16 percent this year.

U.S. light crude had risen to $103.05 a barrel, before eroding gains, after Ecuador shut a key export pipeline and a fire hit a major European natural gas plant.

Surging energy, commodity and food prices are fanning inflation concerns which could tie the hands of central banks keen to cut interest rates to bolster the economy. This is in turn prompting investors to buy safe-haven gold and other basic resources, creating a self-fulfilling cycle.

Emerging sovereign spreads widened 2 basis points while emerging stocks were down 1.2 percent.

The cost of corporate bond insurance rose after Bernanke's warning, with the iTraxx Crossover index, most-widely watched indicator for European credit market sentiment, widening to 595 basis points.

The March Bund future rose 0.5 percent, capitalizing on falling shares.

(Additional reporting by Dominic Lau; Editing by Ruth Pitchford)