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By Herbert Lash
NEW YORK (Reuters) - U.S. and European stocks surged on Friday on expectations the European Central Bank will cut interest rates but the dollar pared gains against the euro after a report said the German government was prepared to take on new debt to lift the economy.
The dollar hit a two-week high against the euro as expectations of ECB stimulus weighed on the single currency and bullish data showing a jump in U.S. homebuilding permits to a seven-month high also helped lift the greenback.
But German and other euro zone government bond yields rose late Friday on a Der Spiegel report. Borrowing costs had plumbed new lows throughout the week as investors unnerved by the prospect of European recession piled into safer assets.
The euro rebounded to pare most losses after Der Spiegel magazine said the German government would be prepared to ditch its balanced budget rule and take on new debt to counter a possible recession.
Germany's Finance Ministry declined to comment on the report.
There has been a rising drumbeat of news recently from German politicians and businesses calling for a stimulus program, said Karl Schamotta, director of global markets strategy at Cambridge Global Payments in Toronto.
"Markets are still betting on a raft of stimulus measures from the ECB in September and that is having a pretty strongly negative effect on the euro," Schamotta said. "But in the near term, this idea that we could see more spending out of Germany is helping to alleviate that."
The German 10-year bund yield <DE10YT=RR> rose to a negative 0.688%, having earlier hit a record low of negative 0.727%. Rates turned negative in March and have trended lower since May.
The rebound in equity markets buoyed investor sentiment, though it is hard to say the recent rout has found a floor despite cheaper prices, said Yousef Abbasi, global market strategist at INTL-FCStone Financial in New York.
U.S. banks are likely to get cheaper because European banks are likely to do so if the ECB does not put together a credible off-set plan for further negative rates for banks, he said.
"That's the concern. Despite some equities looking attractive the macro concern is giving investors a reason to pause and not so aggressively buy the dip," Abbasi said.
Technology shares led Wall Street's advance but U.S. stocks posted a third straight week of declines, battered by the U.S.-China trade row and an "inversion" of 2- and 10-year bond yields that sparked fears of a recession.
MSCI's gauge of stock performance in 47 countries <.MIWD00000PUS> gained 1.18% and its emerging market <.MSCIEF> rose 0.69%. In Europe, the FTSEurofirst 300 <.FTEU3> index of leading regional shares closed 1.23%.