NEW YORK (Reuters) –
Americans slashed spending and the country's business outlook weakened but there were signs of stabilization in global markets on Friday, with interbank rates falling and U.S. stocks posting their best week in 34 years.

But in a sign of the hurdles that lie ahead, the Bank of Japan slashed interest rates, British banking giant Barclays said it was raising $12 billion in capital and a top U.S. lawmaker demanded that banks use money from the country's $700 billion financial bailout package to boost lending.

How to shore up the decimated U.S. housing market, which stands at the root of the global credit crisis, again took center stage on the last Friday before Americans go to the polls to choose their next president.

A U.S. Commerce Department report showed consumers cut monthly spending for the first time in two years in September, evidently bracing for hard times as jobs continue to disappear and credit conditions tighten.

Another survey showed U.S. consumer confidence in October suffered its steepest monthly drop on record.

"Consumers reported the most dismal assessments of their current financial situation ever recorded," the Reuters/University of Michigan Surveys of Consumers said.

Other reports showed business activity fell in the U.S. Midwest and New York City.

But there was at least one hopeful sign, as the closely watched interbank lending rates fell, suggesting that the moves taken by central banks and others to remove blockages in the credit system were working to some extent.

That helped push U.S. stocks higher, with financial stocks leading a rally as investors picked up bargains following recent heavy losses. European shares reversed losses and followed Wall Street higher.

Nevertheless, the Dow Jones Industrial average in October had its worst one-month percentage drop since August 1998, while the dollar was on pace for its best month in more than 17 years.

The Bank of Japan cut interest rates for the first time in seven years on Friday in a move that followed a rate cut by the U.S. Federal Reserve on Wednesday. The European Central Bank and the Bank of England are expected to do the same next week.

In the euro zone, inflation fell to 3.2 percent year-on-year in October, data that was likely to ease any concerns at the ECB about rising prices.

A German government official told Reuters the economy contracted for a second consecutive quarter in the July-September period, putting it in recession.

JPMORGAN HALTS FORECLOSURES

The economy is dominating the final days of the U.S. presidential campaign, which pits Republican John McCain against Democrat Barack Obama on Tuesday.

When the winner takes office in January, he will face the daunting task of overcoming the worst financial crisis in 80 years and guiding a $700 billion bailout that includes $250 billion of cash injections for banks.

The powerful chairman of the U.S. House of Representatives Financial Services Committee, Rep. Barney Frank, said companies receiving public money under the plan must use it for lending or they will be violating the law.

And a labor union leader slammed U.S. Treasury Secretary Henry Paulson's handling of capital injections at worse terms than billionaire investor Warren Buffett got.

Friday brought the year's 17th bank failure, as U.S. regulators closed Florida-based Freedom Bank. Larger regional bank Fifth Third Bancorp agreed to assume Freedom's roughly $250 million of deposits.

Perhaps mindful of the growing political pressure on the U.S. banks, JPMorgan Chase & Co, the largest U.S. bank, said it would halt foreclosures for 90 days as it ramps up a program to make it easier for homeowners to modify their mortgages.

In the latest sign of the widening demands on the rescue program, the Treasury said it will soon allow privately held banks to apply for government capital injections.

FALLOUT SPREADS

Federal Reserve Chairman Ben Bernanke said U.S. backing for debt issued by mortgage finance firms Fannie Mae and Freddie Mac in their current form must remain firm.

Uncertainty over how the U.S. government might treat debt issued by the two government-sponsored-mortgage enterprises in the future has depressed investor appetite, keeping U.S. mortgage rates elevated.

Bernanke's speech coincided with a new report showing that nearly one in five U.S. mortgage borrowers owe more to lenders than their homes are worth.

Meanwhile, fallout from the crunch continued to spread, with Barclays saying it planned to raise 7.3 billion pounds ($12.06 billion) in additional capital from outside investors, including Gulf states Qatar and Abu Dhabi.

Barclays had said earlier it wanted to raise capital but would raise it privately rather than take UK government cash, as rivals Royal Bank of Scotland, Lloyds and HBOS are doing.

Germany's Commerzbank is interested in a state capital injection, according to sources familiar with the situation.

Japan's two-largest banks, Mitsubishi UFJ Financial Group and Mizuho Financial Group, cut their earnings outlooks by more than half on Friday, hit by growing bad-loan costs and a plunging local stock market.

In the troubled U.S. auto sector, a deal to merge General Motors Corp and Chrysler LLC hit an impasse after the Bush administration ruled out funding for it, according to Reuters sources. In Japan, Nissan Motor and Suzuki Motor issued profit warnings.

CREDIT CRUNCH

While interbank rates fell, at the ECB, overnight deposits from banks hit a record high, suggesting banks still preferred to deposit money with the central bank rather than lend to each other.

The Bank of Japan cut its benchmark overnight call rate to 0.30 percent from 0.50 percent, a slightly smaller reduction than the quarter point many had expected.

The rate cut failed to reverse the rise in the low-yielding yen, which has soared on risk aversion.

Japan's Nikkei closed down 5 percent on disappointment at the size of the interest rate cut, while China's main stock index in October suffered its biggest monthly fall since 1994.

October also marked some of biggest monthly price falls for commodities and oil, piling pressure on many emerging market economies that depend on exports for much of their revenue.

Ratings agency Standard & Poor's cut Argentina's foreign currency rating deeper into junk territory, citing economic and political concerns and fiscal pressure.

(Reporting by Reuters bureaus worldwide; Editing by Leslie Adler)

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