Stocks weighed down by US debt fears

LONDON, England [CHECK THE MARKETS: Get the latest numbers from Wall Street]

The United States has until Aug. 2 -- less than a week away -- to reach a deal to increase its $14.3 trillion debt limit or face not being able to pay its bills. That has led to fears the country could default on its financial obligations, which could send shockwaves through financial markets, already stung by the debt crisis that has afflicted Europe for the past 18 months.

Republican leaders had promised a vote on Wednesday in the House of Representatives on a plan to increase the debt limit and avoid America's first-ever default. But the vote was put off until at least Thursday.

House Speaker John Boehner, a Republican, was forced late Tuesday to postpone a floor vote on his plan after the nonpartisan congressional budget office said his proposal would cut spending less than advertised.

Currently, about 40 cents of every dollar spent by the U.S. government is borrowed. Lawmakers are divided over how to get the U.S. government accounts into a healthier state in the longer term.

Even if a deal is reached, there are fears the U.S. could still lose its top credit rating. A downgrade could cost the federal government an extra $100 billion in interest payments a year.

Though most investors think a last-minute deal to raise the debt limit will eventually emerge, the difficulty of reaching an agreement may leave a lasting impact on investor sentiment. That was evident in the price of gold, which is widely used as a safe haven investment and hit a new nominal record high above $1,625 on Wednesday.

"Investors remain hopeful that a deal can be made in time, but the longer the delay goes on, the more entrenched investors fears become," said Joshua Raymond, chief market strategist at City Index.

In Europe, the FTSE 100 index of leading British shares closed down 1.2 percent at 5,856.58 while Germany's DAX fell 1.3 percent to 7,252.68. The CAC-40 in France fared even worse, closing 1.4 percent lower at 3,734.07.

A raft of disappointing earnings in Europe did nothing to lift the mood. Spanish bank Banco Santander SA, French car company Peugeot SA and German pharmaceutical company Merck KGaA were all trading sharply lower after their latest earnings updates.

In the U.S., stocks started the session weakly after an unexpectedly large 2.1 percent monthly drop in durable goods orders in June -- the Dow Jones industrial average was down 0.9 percent at 12,383.84 while the broader Standard & Poor's 500 index fell 1.3 percent to 1,314.86.

Though the durable goods figures are notoriously volatile, the June data badly missed market forecasts for a 0.3 percent increase. Analysts say the uncertainty surrounding U.S. borrowing isn't helping and that a resolution to the dispute could help the wider economy.

"Now if we can lift the cloud of uncertainty over the state of the government's finances, that may be just what businesses need to decide whether or not to increase capital spending," said Jennifer Lee, senior economist at BMO Capital Markets.

Investors will be keeping a close watch on the testimony of senior credit ratings agency staff to Congress later.

As in the stock markets, the prospect of a potential U.S. default remains the main consideration in currencies. Unsurprisingly, the dollar has drifted lower for most of the past few days.

However, the dollar managed to hold relatively steady Wednesday, particularly against the euro. By late afternoon London time, the euro was trading 0.9 percent lower at $1.4369 while the dollar was 0.1 percent higher at 77.98 yen.

The yen's renewed strength has reignited talk that the Bank of Japan will intervene once again to stem the export-sapping rise in the currency. In March, after a devastating earthquake and tsunami, it, along with other major central banks around the world, intervened in the markets when the dollar was trading around the 76 yen mark.

The currency's spike weighed on the country's Nikkei 225 stock average as much of Japan's economic well-being is dependent on the performance of its exporters. It closed 0.5 percent lower at 10,047.19

Elsewhere, South Korea's Kospi edged up 0.3 percent to finish at 2,174.31 while Hong Kong's Hang Seng Index fell 0.1 percent to close at 22,541.69.

Chinese shares gained strongly as investors snapped up bargains two days after a sell-off led by railway shares following a deadly train crash in the country's east. The Shanghai Composite Index gained 0.8 percent to close at 2,723.49 and the smaller Shenzhen Composite Index gained 1.7 percent to end at 1,190.83.

Oil prices dropped to near $99 a barrel after a report showed U.S. crude supplies unexpectedly jumped last week, suggesting demand may be weakening. The main New York oil contract was down $1.09 to $98.50 a barrel in electronic trading on the New York Mercantile Exchange.

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