U.S. stocks lowest since 2003, Fed warns of contraction

By Patricia Zengerle

WASHINGTON (Reuters) - U.S. and European stocks fell to their lowest levels in 5-1/2 years on Wednesday, as prospects faded for a Washington bailout of the auto industry and data showed U.S. consumer prices dropped at a record pace in October.

Stock prices were also hit also by Federal Reserve forecasts for the U.S. economy to contract in the first half of through 2009, amid concern about the potential for deflation.

U.S. consumer prices plummeted 1.0 percent last month, raising the prospect of deflation if consumer demand fails to pick up. Construction starts on U.S. homes also hit a record low in October, reports showed.

The Dow Jones industrial average dropped 5.07 percent to close below 8,000 for the first time since March 2003, while the S&P 500 Index and NASDAQ Composite each plunged more than 6.0 percent.

"We're witnessing the worst market crash in most people's lifetimes," said David Bianco, chief U.S. equity strategist at UBS in New York. "People seem to enjoy telling each other how bad its going to get and working themselves into a frenzy. It's just becoming silly."

Falling bank stocks and lower commodity prices dragged European shares to their lowest close in 5-1/2 years, and Japanese stocks were hit by concerns about exports and the auto industry.

GRIM OUTLOOK

The U.S. Federal Reserve also released minutes of their October policy meeting showing some Fed officials believed even deeper interest rates cuts may be needed if growth slows further.

"Members anticipated that economic data over the upcoming intermeeting period would show significant weakness in economic activity, and some suggested that additional policy easing could well be appropriate at future meetings," the minutes of the October 28-29 meeting said.

Earlier, minutes of the Bank of England's last meeting, when it cut interest rates by a sharp 1.5 percentage points, showed it had considered an even bigger reduction to tackle the recession and raised bets on further cuts ahead.

Fund managers are embracing defensive assets such as utility stocks, government bonds and cash. U.S. and European debt prices rose on signs of fading inflation.

Investors sold off Latin American currencies, stocks and bonds, taking their money to safer havens on fears of more global weakness.

Bonds backed by U.S. commercial real estate loans fell for a second day on fear the fast-weakening U.S. economy could lead to a wave of defaults on loans on properties such as office buildings, retail stores and hotels.

PLEADING WITH CONGRESS

The "Big Three" U.S. carmakers -- General Motors, Ford Motor Co and Chrysler LLC -- pleaded for help before the U.S. Senate Banking Committee for a second day.