Stocks rally on hopes for central bank boost

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NEW YORK (CNNMoney) -- U.S. stocks closed sharply higher Thursday as panicky investors reacted to reports that central banks are ready to provide liquidity to financial markets following Greece's crucial election on Sunday in case it becomes necessary.

The Dow Jones industrial average (INDU) jumped 155 points, or 1.2%, the S&P 500 (SPX) gained 14 points, or 1.1%, and the Nasdaq (COMP) added 18 points, or 0.6%.

"The market is jittery leading up the the Greek election, and a rumor like that will definitely spark a move higher," said Joe Saluzzi, co-head of equity trading at Themis Trading.

Saluzzi warned that stocks will likely continue to swing sharply through Friday, as investors brace of Sunday's vote.

The concern is that anti-austerity political parties in Greece will win enough seats in parliament to derail the bailout program the crippled nation secured earlier this year. The runoff is being viewed as a pivotal moment that could determine if Greece remains a member of the euro currency union or not.

Separately, Bank of England Governor Mervyn King announced plans to take steps to protect the British financial system and economy from the euro zone's deepening crisis.

"What I can say tonight is that the Bank and the Treasury are working together on a 'funding for lending' scheme that would provide funding to banks for an extended period of several years, at rates below current market rates," said King in a speech at banquet in London.

Earlier in the day, a rally in stocks was fueled by growing speculation and hope that the Federal Reserve may soon pull the trigger on more economic stimulus in light of a weakening job market.

Calls for the Fed to take more simulative steps have grown for several months.

Hopes are that the central bank will either launch a third round of bond purchases, known as quantitative easing or QE3, or extend its current policy of Operation Twist, which is set to expire at the end of June.

"I think QE3 is becoming a greater possibility as we march into summer," said Dave Hinnenkamp, CEO at KDV Wealth Management. "The jobs picture has really been dimming as of late."

On Thursday, the Labor Department reported that filings for initial unemployment benefits rose yet again. And the government's monthly jobs report, released two weeks ago, showed a slowdown in hiring.

The Fed holds a two-day monetary policy meeting next week, with chairman Ben Bernanke scheduled to hold a news conference at the conclusion of the meeting Wednesday afternoon.

Meanwhile, concerns remain heightened about Spain, after the yield on 10-year Spanish bonds peaked at 7.02% -- the highest level since the euro was introduced in 1999. The same level signaled the need for bailouts in other European countries earlier in the crisis, but Spanish yields slid to 6.97% later Thursday.

The spike in borrowing costs came a day after rating agencies Moody's and Egan-Jones both downgraded Spain, citing bleak economic prospects and the country's high debt load.

Spain recently requested up to €100 billion from the European Union to recapitalize its ailing banks. But with the higher borrowing costs, investors are worried the country will need even more help.

"Unless the Europeans come up with a policy response soon, it's looking increasingly like Spain will need a (government) bailout on top of support for the banks," said Nick Stamenkovic, fixed income strategist at RIA Capital Markets in Edinburgh. He estimated the government could need €50 billion.

Investors are also increasingly worried about a worsening situation in Italy, which is an even larger economy. Italy was able to sell €3 billion of its 3-year bonds, and an additional €1.5 billion of the 10- and 15-year debt at an auction Thursday. But it had to pay significantly more than at its previous auction, with the yield on the 3-year bonds rising to 5.3% from 3.9% in May.

"Italy is clearly being caught up the contagion that is affecting Spain," Stamenkovic said. "But there's a bit of relief that they did their targets. Yields are off their earlier highs."

U.S. stocks ended lower Wednesday amid ongoing concerns about Spain and the European debt crisis.

Economy: The Labor Department reported that retail prices fell 0.3% in May compared to April levels, driven down by the falling gas prices. It was the first drop in the Consumer Price Index in two years, and a slightly bigger drop than forecast.

Companies: Shares of cell phone maker Nokia (NOK) dropped after the Finnish company announced it was cutting 10,000 jobs worldwide, and warned that competition in the smart phone business would hurt results somewhat more than expected in the second quarter.

Shares of meat producer Smithfield Foods (SFD, Fortune 500) slipped after the company reported a bigger-than-forecast drop in earnings.

Shares of grocery chain Kroger (KR, Fortune 500) rose, after it reported a better than expected increase in earnings and a $1 billion share buyback program.

Yammer (JIVE) shares popped on reports that Microsoft (MSFT, Fortune 500) is talks with the business social networking firm to buy it out.

AOL's (AOL) stock fell after shareholders defied an activist's attempt to unseat three directors by voting to re-elect all eight members of AOL's board, including CEO Tim Armstrong.

World markets: European stocks closed mixed. Britain's FTSE 100 (UKX) shed 0.2% and the DAX (DAX) in Germany lost 0.2%, while France's CAC 40 (CAC40) ended barely in positive territory.

Asian markets finished in the red. The Shanghai Composite (SHCOMP) fell almost 1%, while the Hang Seng (HSI) in Hong Kong dropped 1.2% and Japan's Nikkei (N225) shed 0.2%.

Currencies and commodities: The dollar fell against the euro, the British pound and the Japanese yen.

Oil prices rose after OPEC said it will leave its official production ceiling unchanged, dashing hopes for an official increase that could have sent crude prices lower. Crude for July delivery rose $1.29 to settle at $83.91.

Gold futures for August delivery edged up 20 cents to settle at $1,619.60 an ounce.

Bonds: The price on the benchmark 10-year U.S. Treasury fell, pushing the yield up to 1.63% from 1.60% late Wednesday.