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(Reuters) - Stocks ended the worst week in a year as time runs out on Washington to reach agreement before the government loses its ability to borrow money.

The S&P 500 fell every day this week and was down 3.9 percent for the week as legislators failed to work out an agreement to raise the federal borrowing limit, which expires on Tuesday. Investors also worry about the likelihood of a U.S. credit downgrade.

The CBOE Market Volatility Index .VIX, a gauge of investor fear, jumped as much as 9 percent to its highest level since mid-March before paring its rise.

Natalie Trunow, chief investment officer of equities at Calvert Investment Management in Bethesda, Maryland, said investors are taking a more defensive stance, possibly moving more into cash.

"It's frustrating for investors and for U.S. citizens to see this unfold in the way it has been," she said.

"From an overall asset allocation standpoint, in an environment like this, you get bigger moves into cash and safe havens."

The Dow Jones industrial average .DJI was down 96.87 points, or 0.79 percent, at 12,143.24. The Standard & Poor's 500 Index .SPX was down 8.39 points, or 0.65 percent, at 1,292.28. The Nasdaq Composite Index .IXIC was down 9.87 points, or 0.36 percent, at 2,756.38.

U.S. President Barack Obama told Republicans and Democrats to find a way "out of this mess." The United States will be unable to borrow money to pay its bills if Congress does not raise the debt limit by August 2.

A second attempt for a vote in the House of Representatives is expected after the close of trading on Friday after a bill was modified to try to win over more conservative lawmakers. The measure has little chance of passing in the Senate, however.

At least one credit rating agency has said it is likely to lower the United States' prized tripe-A rating if the cuts in Washington don't go far enough.

"Will the deal be enough to satisfy the credit rating agencies is really what's at stake here," Trunow said, whose firm manages about $14.8 billion.

The S&P utility index .GSPU is down 2.1 percent for the week, while the Dow is down 4.2 percent and the Nasdaq is down 3.6 percent for the week.

Major indexes also posted losses for the month: the Dow and S&P 500 each lost 2.2 percent while the Nasdaq fell 0.6 percent.

The S&P 500 briefly fell below its 200-day moving average, seen as key support, and bounced back from its worst levels of the day.

Weak economic data also weighed on equities. The U.S. economy stumbled badly in the first half of this year and came dangerously close to contracting in the January-March period.

Among declining stocks, Chevron Corp (CVX.N), the second-largest U.S. oil company, fell 1 percent to $104.02 despite reporting a 43 percent jump in quarterly profit that beat estimates.

Energy led declines on the Dow on Friday, but the industrial sector was among the hardest hit for the week. The S&P industrial sector .GSPI lost 6.1 percent this week, following disappointing results from companies including Illinois Tool Works (ITW.N).

"The industrial sector appears to be pricing in lower earnings ahead," said Chris Burba, a short-term market technician at Standard & Poor's in New York.

Some 8.58 billion shares changed hands on the New York Stock Exchange, NYSE Amex and Nasdaq, above the daily average of 7.48 billion.

Declines outweighed advances on the NYSE by about 2 to 1, while on Nasdaq losers outpaced winners by about 7 to 5.

A bitter mood prevailed on Capitol Hill as lawmakers struggled on Saturday to find a compromise measure to lift the nation's $14.3 trillion debt, as talks to avert a ruinous default went down to the wire.

A day after the Republican-controlled House of Representatives passed a bill to cut the deficit and raise the ceiling on government borrowing, the debt saga shifted to the Democratic-led Senate where lawmakers scrambled for a deal.

Senate Democrats pushed ahead with their own plan, but sought to attract bipartisan support by adding some elements of a proposal offered by Senate Republican leader Mitch McConnell.

But Senate Republicans appeared to have the votes to block that bill and the House quickly crushed the Democrats' proposal before the Senate acted on it, rejecting the measure 246 to 173 in a fast-tracked vote set by the Republican leadership.

Back-channel talks held the best hope for a compromise.

President Barack Obama was to meet in the afternoon with Senate Democratic leader Harry Reid and the House Democratic leader Nancy Pelosi. McConnell also wants to meet with the White House.

Unless Congress raises the debt ceiling, the government would be barred from further borrowing after Tuesday, according to the U.S. Treasury, and could quickly run out of money to pay all its bills.

The world has watched with growing alarm as political gridlock in Washington has brought the world's largest economy close to an unprecedented default, threatening to plunge financial markets and economies around the globe into turmoil.

Forty-three Senate Republicans signed a letter rejecting Reid's plan, a sign the measure does not have the support needed to clear a 60-vote procedural hurdle in the Senate.

"What will they vote for? Do they have any ideas? Let me know," Reid said on the Senate floor.

Democrats hope to convince some Republicans who signed their letter to allow the bill to clear the hurdle, at which point they could change it, a Democratic aide said.

WHITE HOUSE TALKS

McConnell called on Reid to move up a vote on the Democratic plan that had been set for 1 a.m. EDT (0500 GMT) on Sunday so the two sides could begin talks with the White House.

"We can't do it by ourselves, it has to have the only person in America who can sign something into law," McConnell said.

Obama used his weekly radio and Internet address to urge lawmakers to strike a deal and head off what he has said would be an "inexcusable" default.

In a vote scheduled to send a message to Senate Democrats, the Republican-controlled House defeated a version of the Reid plan, which fell well short of the supermajority vote needed for quick passage.

The drawn-out standoff has put the United States at risk of losing its top-notch AAA credit rating. A ratings downgrade could prompt global investor flight from U.S. bonds and the dollar, raising borrowing costs for Americans when the economy is already frail, growing at an anemic rate of 1.3 percent in second quarter, according to government data.

U.S. stocks endured their worst week in a year as the uncertainty made investors shy away from riskier assets and the dollar slumped to a record low against the safe-haven Swiss franc. Much worse could be in store if a U.S. debt deal doesn't appear to be on track by the time markets open on Monday.

Senate Democrats' debt-limit proposal, which would cut deficits by $2.2 trillion over 10 years, was revised by Reid to incorporate parts of a "backup plan" first proposed by McConnell. As envisioned, Obama would be given authority to raise the debt ceiling in three stages to cover U.S. borrowing needs through the 2012 elections when he is running for a second term.

Senate Democrats and Republicans agree about the main contours of the deal. The main point of contention remains what sort of mechanism should be in place to ensure that Congress will agree to further budget savings after a special committee makes recommendations, an aide said.

Republicans want the enforcement mechanism to be another debt limit vote late this year or early next year, while Democrats have proposed automatic tax hikes and spending cuts.

Obama says any plan that would require another showdown over the debt limit in a few months would be unacceptable because it would lead to economic uncertainty, putting a damper on jobs and growth.

With Republicans pushing to have the White House join the talks, Vice President Joe Biden, who has a rapport with McConnell from his years in the Senate, could emerge as a key player in final negotiations.

Unless there is major progress toward a debt deal, the U.S. Treasury could be forced on Sunday before Asian markets open to detail plans on which bills the government would pay if Tuesday's deadline is missed. Analysts believe it will stop other government spending to ensure bondholders are paid to avert a wide-scale financial crisis.

(Reuters) - British and Japanese officials warned Sunday of disastrous consequences for the global economy if last-minute talks among lawmakers in Washington failed to agree on raising the U.S. borrowing limit and averting a debt default.

Governments across the world fear that because of the key role of the U.S. dollar in global banking and trading systems, there could be severe instability when Asian financial markets reopen Monday if a U.S. debt deal is not in sight by then.

In Washington, Senate Minority Leader Mitch McConnell, the top Senate Republican who is playing a key role in the debt talks, said "we're very close" to a $3 trillion deal that would raise the debt ceiling while cutting the U.S. budget deficit.

But a senior White House official warned that an agreement was "not there yet."

"If they get this one wrong and there's a default -- we don't expect that, we think that they will sort this out -- but if that were to happen, it has consequences for every family and every business in this country and all across the world," said Danny Alexander, Chief Secretary to the British Treasury.

"I think in the end the politicians on Capitol Hill can see that the precipice they are looking over is one that they are going to step back from," Alexander told BBC television.

"But it is something that would have a big effect on the global financial system and on the global economy, where the United States is one of our major trading partners, that could have really big implications for the United Kingdom."

In Tokyo, sources familiar with Japan's international and monetary affairs said they were increasingly concerned that markets might be too optimistic about prospects for a lasting solution to the crisis.

Japanese officials still hope Washington can strike a deal and if that proves impossible, will give priority to interest payments to international holders of U.S. Treasury debt to limit the immediate market impact, the sources said.

But Tokyo's concern is that if the crisis drags on without a clear and long-term solution, markets may be thrown into turmoil in the same way that they suffered when U.S. investment bank Lehman Brothers collapsed in September 2008.

"If there is a default, the impact on global markets will be huge," said one of the sources, who declined to be named because of the sensitivity of the matter.

Another Japanese source said, "Nobody thought Washington would let Lehman collapse. But look what happened."

U.S. lawmakers have set themselves a Tuesday deadline to reach agreement and the U.S. Treasury has said it will run out of borrowing room on that day, although analysts think the government may have enough cash to keep servicing its debt and paying its bills through the middle of this month.

CHINA

Britain is the third largest foreign holder of U.S. Treasury debt and Japan is the second largest. China is the biggest with well over $1 trillion invested in U.S. Treasuries; about two-thirds of its $3.2 trillion of foreign exchange reserves are estimated to be held in dollar assets.

Saturday the official People's Daily newspaper, the mouthpiece of the Chinese Communist Party, castigated the U.S. handling of the debt crisis in an editorial as "irresponsible" and "immoral."

It said the U.S. democratic system was to blame for the "farce," claiming that "not a single representative has considered the world, and even U.S. national interests are being banished from the mind."

Friday a senior economic policymaker in the euro zone, who declined to be named, told Reuters he was optimistic Washington would solve the problem but expressed surprise and anger that U.S. politicians were "playing chicken" with an issue of such importance for the global economy.

Euro zone leaders are struggling to control sovereign debt crises in several countries in their region, and the U.S. debt problem is making this more difficult by adding to upward pressure on the yields of government bonds in those weak states.

If there is no U.S. debt deal by Monday morning, central banks around the world are expected to stand ready to provide emergency supplies of money to commercial banks in case the banks become too nervous to lend to each other.

Japan's first defense will be to ensure that Japanese financial institutions have a sufficient supply of dollars, the sources in Tokyo indicated.

The Bank of Japan believes Japanese commercial banks have sufficient dollar cushions but will use its dollar swap arrangement with other central banks to prevent a dollar squeeze in case of market turmoil.

In late June, the U.S. Federal Reserve agreed to extend liquidity swap arrangements with other major central banks until August 1, 2012.

The Japanese central bank is also prepared to flood markets with yen through its open market operations in case interbank borrowing costs spike, BOJ officials say.

In Europe, there were minor signs of strain in the money markets last week with some banks becoming unable to take out longer-term dollar loans, but the effect was small since banks still expected Washington would reach a deal.

The European Central Bank already offers unlimited euro loans to banks in some of its money market operations as part of its response to past crises, and it could use that policy to cope with any market problems this week.

A spokesman for the Swiss central bank said, "The Swiss National Bank is ready to react appropriately at any time to market disruptions."

(Reuters) - HSBC Holdings Plc (HSBA.L) should unveil a half-year profit of near $11 billion (6 billion pounds) on Monday, flat from a year earlier as weak investment bank trading and wobbly U.S. and European economies offset growth in Asia.

New HSBC CEO Stuart Gulliver is overhauling Europe's biggest bank by slashing costs by up to $3.5 billion, selling its U.S. credit card arm and other assets, and retreating from countries where it is sub-scale.

The aim is to sharpen the focus on Asia and investors want to see progress made on that plan.

HSBC is the first of Britain's big banks to report and should show a pretax profit for the six months to the end of June of $10.9 billion, compared with $11.1 billion a year earlier, according to the average of forecasts from 12 banks and brokerages polled by Reuters.

Earnings will be hurt by a slump in fixed income trading in the second quarter, which has hit rivals including Credit Suisse (CSGN.VX) particularly hard. Revenue from HSBC's global banking and markets unit is likely to fall 8 percent on the year to $10 billion, analysts at Citi forecast.

A stuttering U.S. economy could also slow the improvement in bad debts at HSBC's U.S. consumer loans portfolio, which it is running down, analysts said.

Gulliver unveiled his far-reaching plan in May to slash costs and cut back in retail banking to revive flagging profits and returns.

Gulliver intends to sell HSBC's U.S. credit card portfolio, which has more than $30 billion in assets, a move which would free up capital. Capital One Financial Corp (COF.N) and Wells Fargo (WFC.N) are among the bidders, sources have said.

Another suitor could be Barclays (BARC.L).

HSBC is also looking to sell upstate New York branches as it shrinks its network of 475 U.S. branches. Altogether it is looking to sell, shut or slim down retail banking in 39 countries. So far, it has said it will exit Russia and Poland.

The bank is likely to axe thousands of jobs as part of the overhaul, but it is probably too early to see an improvement in the cost line, analysts said.

Pretax profit will include a negative adjustment on the value of debt the bank carries, expected to be around $600 million. Underlying profit of $11.5 billion would be up almost a fifth from a year ago.

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(Reuters) - President Barack Obama on Sunday announced a last-minute deal to raise the U.S. borrowing limit and urged lawmakers to "do the right thing" and approve the proposed agreement to avert a catastrophic default.

Laying out the endgame in the crisis just two days before a deadline to lift the U.S. debt ceiling, the White House and both Republican and Democratic leaders in Congress said the compromise would cut about $2.4 trillion from the deficit over the next 10 years.

Now that top lawmakers have sealed a deal, both the Senate and House of Representatives are expected to vote on Monday. While Senate approval is likely, the agreement's fate may be less certain in the House.

After weeks of acrimonious impasse and with the final outcome hinging on support from recalcitrant lawmakers, Obama pressured both sides to carry to fruition the accord hammered out behind closed doors.

"The leaders of both parties in both chambers have reached an agreement that will reduce the deficit and avoid default -- a default that would have had a devastating effect on our economy," Obama told reporters at the White House.

"I want to urge members of both parties to do the right thing and support this deal with your votes over the next few days," Obama said.

The plan involved a two-step process for reducing the U.S. deficit. The first phase calls for about $900 billion in spending cuts over the next decade and the next $1.5 trillion in savings must be found by a special congressional committee. Congress must act by December 23, 2011, under the deal.

Republicans had insisted on deep spending cuts before they would consider raising the $14.3 trillion limit on U.S. borrowing, turning a normally routine legislative matter into a dangerous game of brinkmanship.

Financial markets showed immediate signs of relief after becoming unnerved in recent days as lawmakers neared an August 2 deadline to raise the limit on America's borrowing or risk the world's largest economy running out of money to pay its bills.

The Japanese stock index rose 1.8 percent, U.S. stock futures built on earlier gains and the U.S. dollar rose modestly against the yen and the Swiss franc. Gold fell more than 1 percent, indicating investors had begun to shift out of safe havens.

"For the rally to be durable, markets will need more than this downpayment agreement," said Mohamed El-Erian, co-chief investment officer at PIMCO, the world's biggest bond fund.

"They will look to a more coherent fiscal reform to emerge from the second step and, more generally, for additional measures to remove structural impediments to growth and jobs," he said.

While the deal means the United States is unlikely to default, it is far from certain whether the plan agreed by the White House and lawmakers goes far enough in reducing the deficit to appease credit ratings agency S&P, which has threatened to strip America of its top-notch AAA rating.

A deal would ease the immediate crisis but repercussions will be felt for years to come. Bitter brinkmanship has turned dysfunction seemingly into the norm in Washington, undercut America's stature as the world's capitalist superpower and set the stage for a deeply ideologically 2012 presidential race when President Barack Obama is seeking re-election.

SELLING THE DEAL

Congressional leaders will now have to gauge whether they have the votes to pass the deal -- which has sharp spending cuts and no new taxes -- in the Senate and the House. In the house the political calculus is complicated by the entrenched opposition of some members affiliated with the conservative Tea Party movement.

House of Representatives Speaker John Boehner, who will face opposition from those conservatives in his ranks, told Republicans he backed the accord but that it was not the "greatest deal in the world." Already, some conservatives in his party said they would not sign on.

Democratic Leader Nancy Pelosi, a leading liberal considered crucial to delivering enough Democratic votes to offset Republican defections, suggested earlier that the terms under negotiation would be a tough sell in her party.

But in the Senate, passage appeared more certain.

"I am relieved to say that leaders from both parties have come together for the sake of our economy to reach a historic, bipartisan compromise," Senate Democratic Leader Harry Reid said on the Senate floor.

Senate Republican Leader Mitch McConnell followed, saying: "We can assure the American people tonight that the United States of America will not for the first time in our history default on its obligations," McConnell said.

(Reuters) - President Barack Obama on Sunday announced a last-minute deal to raise the U.S. borrowing limit and urged lawmakers to "do the right thing" and approve the proposed agreement to avert a catastrophic default.

Laying out the endgame in the crisis just two days before a deadline to lift the U.S. debt ceiling, the White House and both Republican and Democratic leaders in Congress said the compromise would cut about $2.4 trillion from the deficit over the next 10 years.

Now that top lawmakers have sealed a deal, both the Senate and House of Representatives are expected to vote on Monday. While Senate approval is likely, the agreement's fate may be less certain in the House.

After weeks of acrimonious impasse and with the final outcome hinging on support from recalcitrant lawmakers, Obama pressured both sides to carry to fruition the accord hammered out behind closed doors.

"The leaders of both parties in both chambers have reached an agreement that will reduce the deficit and avoid default -- a default that would have had a devastating effect on our economy," Obama told reporters at the White House.

"I want to urge members of both parties to do the right thing and support this deal with your votes over the next few days," Obama said.

The plan involved a two-step process for reducing the U.S. deficit. The first phase calls for about $900 billion in spending cuts over the next decade and the next $1.5 trillion in savings must be found by a special congressional committee. Congress must act by December 23, 2011, under the deal.

Republicans had insisted on deep spending cuts before they would consider raising the $14.3 trillion limit on U.S. borrowing, turning a normally routine legislative matter into a dangerous game of brinkmanship.

Financial markets showed immediate signs of relief after becoming unnerved in recent days as lawmakers neared an August 2 deadline to raise the limit on America's borrowing or risk the world's largest economy running out of money to pay its bills.

The Japanese stock index rose 1.8 percent, U.S. stock futures built on earlier gains and the U.S. dollar rose modestly against the yen and the Swiss franc. Gold fell more than 1 percent, indicating investors had begun to shift out of safe havens.

"For the rally to be durable, markets will need more than this downpayment agreement," said Mohamed El-Erian, co-chief investment officer at PIMCO, the world's biggest bond fund.

"They will look to a more coherent fiscal reform to emerge from the second step and, more generally, for additional measures to remove structural impediments to growth and jobs," he said.

While the deal means the United States is unlikely to default, it is far from certain whether the plan agreed by the White House and lawmakers goes far enough in reducing the deficit to appease credit ratings agency S&P, which has threatened to strip America of its top-notch AAA rating.

A deal would ease the immediate crisis but repercussions will be felt for years to come. Bitter brinkmanship has turned dysfunction seemingly into the norm in Washington, undercut America's stature as the world's capitalist superpower and set the stage for a deeply ideologically 2012 presidential race when President Barack Obama is seeking re-election.

SELLING THE DEAL

Congressional leaders will now have to gauge whether they have the votes to pass the deal -- which has sharp spending cuts and no new taxes -- in the Senate and the House. In the house the political calculus is complicated by the entrenched opposition of some members affiliated with the conservative Tea Party movement.

House of Representatives Speaker John Boehner, who will face opposition from those conservatives in his ranks, told Republicans he backed the accord but that it was not the "greatest deal in the world." Already, some conservatives in his party said they would not sign on.

Democratic Leader Nancy Pelosi, a leading liberal considered crucial to delivering enough Democratic votes to offset Republican defections, suggested earlier that the terms under negotiation would be a tough sell in her party.

But in the Senate, passage appeared more certain.

"I am relieved to say that leaders from both parties have come together for the sake of our economy to reach a historic, bipartisan compromise," Senate Democratic Leader Harry Reid said on the Senate floor.

Senate Republican Leader Mitch McConnell followed, saying: "We can assure the American people tonight that the United States of America will not for the first time in our history default on its obligations," McConnell said.

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Aug 1 (Reuters) - The euro extended declines against the dollar to hit a more than one-week low on Monday, as stock losses and weak U.S. manufacturing data dented risk appetite.

The euro fell as low as $1.4190 on trading platform EBS EUR=EBS, the weakest since July 21. It was last at $1.4198, down 1.4 percent