* U.S. lays groundwork for possible action against Syrian government
* Brent sets 6-month high as West weighs strike on Syria
* Dow, S&P 500 falls more than 1 pct; Nasdaq off 2 pct
* Congress must act to raise debt limit-U.S. Treasury Secretary
By Angela Moon
NEW YORK, Aug 27 The possibility of Western military action against the Syrian government pushed oil prices to a six-month high on Tuesday and sent equities worldwide sharply lower.
Both Brent and U.S. crude gained upward of more than $3 a barrel as fears mounted that Western intervention could further destabilize the Middle East, which pumps a third of the world's oil.
Wall Street stocks fell, with the Dow Jones industrial Average and S&P 500 off more than 1 percent and Nasdaq down more than 2 percent. Investor nervousness was reflected in a jump of more than 15 percent on the CBOE volatility index, Wall Street's so-called fear gauge, in the last two days.
A number of nations and groups, including Britain, France, Canada and the Arab League, joined the United States in urging a firm response to Bashar al-Assad's government and said the world shouldn't stand by as chemical weapons are used. However Russia, as Syria's key ally and arms supplier, opposes military action.
Western sources who attended a meeting in Istanbul between envoys of an alliance opposed to Assad and the Syrian National Coalition said "action to deter further use of chemical weapons by the Assad regime could come as early as in the next few days."
"This is the largest geopolitical risk since the start of the Iraq war. I am not saying it will escalate to that point, but this war of words with Russia is the first time the U.S. is pitted against another global in a long time. That creates an uncertainty this market is not accustomed to," said Mike O'Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.
Adding to the selloff, U.S. Treasury Secretary Jack Lew said it was essential for Congress to raise the government's borrowing limit by mid-October or the country will face an unprecedented default. He warned that the administration would not allow for it to be used as political leverage.
In Europe, stocks registered their biggest daily drop in two months as the threat of a military strike against Syria prompted investors to take profit on some of this summer's best performers and to buy insurance against future losses.
A rise in U.S. government debt prices and stronger Swiss and Japanese currencies suggested the flight to safety was gathering momentum.
The benchmark 10-year U.S. Treasury note was up 18/32, with the yield at 2.7214 percent.
The safe-haven yen and Swiss franc gained and riskier currencies like the Australian and New Zealand dollars fell as geopolitical tensions rose.
The Swiss franc and the yen usually climb in times of financial market stress and geopolitical uncertainty, while growth-linked higher-yielding currencies sell off.
The dollar fell 1.4 percent versus the yen to 97.12 yen , pulling away from a near three-week high of 99.15 yen set on Friday. The dollar also fell 0.6 percent against the Swiss franc to 0.9178 franc, while the euro was down 0.5 percent at 1.2286 francs.
The growth-linked Australian dollar was down 0.7 percent at US$0.8964, while against the yen it lost nearly 2.0 percent to 87.20 yen.
Spot gold rose to its highest since early June at around $1,420 an ounce. Gold has rallied more than $200 since late June, when prices hit three-year lows.
Emerging market currencies such as the Turkish lira and the Indian rupee bore the brunt of the flight as doubts over the Syrian situation added to pressure from investors' bracing for an end to the supply of cheap dollars from the U.S. Federal Reserve's monetary stimulus.
The Indian rupee lost as much as 2.5 percent to reach a record low of 65.93 per dollar, while Turkey's lira weakened to 2.03 to the dollar, also a record low. Turkey's share index also slid.
OIL AND SHARES
Brent crude futures settled at $114.36 a barrel, up $3.63 or 3.28 percent, their biggest daily percentage gain since early May. U.S. crude rose settled at $109.01 a barrel, up $3.09 or 2.92 percent.
Russia's rouble, which normally benefits from stronger oil prices, hit a four-year low against the dollar-euro basket on concern over the situation in Syria.
Russia has urged Washington not to use military force against Assad's government. Traders said its response to any U.S. move against Syria would be key to whether the current shift into safer assets turned into a major flood.
On Wall Street, the Dow Jones industrial average was down 148.43 points, or 0.99 percent, at 14,798.03. The Standard & Poor's 500 Index was down 23.46 points, or 1.42 percent, at 1,633.32. The Nasdaq Composite Index was down 72.56 points, or 1.98 percent, at 3,585.01.
The pan-European FTSEurofirst 300 index of top European shares ended down 1.7 percent at 1,202.36, trimming its gains since the start of July to 4.4 percent.
Asian markets fell 1.2 percent, while Tokyo's Nikkei ended 0.7 percent lower. That left the MSCI all-country world equity index down 1.2 percent for a second day of falls, though it remains off its lows for the month.