updated 6/6/2007 8:00:58 AM ET 2007-06-06T12:00:58

Wall Street skidded lower Tuesday after comments from Federal Reserve Chairman Ben Bernanke and a strong reading on the service sector suggested the central bank has little reason to lower interest rates.

Major Market Indices

Bernanke’s speech by satellite to an international monetary conference in South Africa Tuesday spurred investors to sell a day after the Dow and Standard & Poor’s 500 index edged up to new highs. Bernanke remarked that the economy will recover from its recent feeble performance, despite a housing slump that he said could drag on the economy for longer than anticipated.

Bernanke’s forecast of rebounding growth, as well as his assessment that inflation is “ebbing” but remains “somewhat elevated,” made it appear unlikely the Fed will lower rates anytime soon, a disappointment for Wall Street. Behind the stock market’s surge, driven primarily by strong takeover activity, has been a backdrop of stable interest rates and the possibility of a rate cut; recently, though, with bond yields creeping up, some investors fear the Fed may alter that climate.

“The market is hoping for slow growth and moderate inflation, and now there’s concern they might have to bump up rates in the second half of the year,” said Jim Herrick, director of equity trading at Baird & Co.

While the Fed chairman’s comments stalled a months-long rally, many analysts have been predicting Wall Street would soon pull back before heading higher later this year. Before Tuesday’s decline, the Dow and the S&P 500 had risen more than 8 percent since the beginning of the year.

A robust report on the service sector from the Institute for Supply Management failed to boost stocks. The ISM’s nonmanufacturing index came in at 59.7 in May, higher than expected and up from April’s reading of 56.0. A reading above 50 indicates expansion in the service sector, a diverse group of industries that represents about 80 percent of U.S. economic activity. Investors want to see growth but worry that if it’s too robust, it could prompt a rate hike.

According to preliminary calculations, the Dow fell 80.86, or 0.59 percent, to 13,595.46, after earlier falling more than 100 points.

Broader indexes also retreated. The Standard & Poor’s 500 index fell 8.23, or 0.53 percent, to 1,530.95, while the Nasdaq composite index shed 7.06, or 0.27 percent, to 2,611.23.

Bonds slipped after Bernanke’s comments and the strong service sector data.

“The good news is he did say this residential real-estate morass won’t leach out into the main economy. The bad news is he’s still beating the drum pretty hawkishly on inflation,” said Jack Ablin, chief investment officer at Harris Private Bank.

The yield on the benchmark 10-year Treasury note rose to 4.98 percent from 4.93 percent late Monday. The 10-year yield is trading at 9-month highs, and appears poised to break through 5 percent, a level not reached since August 2006.

Stocks sold off further after a midday speech by U.S. Treasury Secretary Henry Paulson, who said he has been pressuring China to make its exchange rate more flexible. If the yuan is given the chance to rise in value, it could have a dampening effect on the U.S. dollar.

The dollar fell against other major currencies, while gold prices edged lower.

In takeover news, telecommunications company Avaya Inc. said late Monday it agreed to an $8.2 billion offer by private equity firms Silver Lake and TPG Capital. Avaya rose 31 cents to $17.03.

Retail stocks took a hit after home goods seller Bed Bath & Beyond Inc. late Monday warned its fiscal first-quarter earnings may fall below analyst estimates. The stock lost $2.20, or 5.4 percent, to $38.27.

The biggest decliner among the 30 Dow component companies was DuPont Co., downgraded by Lehman Brothers to an “equal weight” rating from “overweight.” The chemicals company fell 95 cents to $52.24.

In other corporate news, Ryanair Holdings PLC reported a record full-year 2006 profit despite higher fuel prices and tough competition, but made a cautious forecast for 2007. The Irish airline’s U.S. shares fell $1.69, or 4.2 percent, to $38.66.

Google Inc. rose $11.77, or 2.3 percent, to an all-time high of $518.84. The search leader signed an agreement with Salesforce.com Inc. to cooperate on online advertising.

Declining issues outnumbered advancers by about 3 to 1 on the New York Stock Exchange, where volume came to 1.51 billion shares, compared to 1.34 billion on Monday.

The Russell 2000 index of smaller companies was down 6.84, or 0.80 percent, at 848.25.

Crude oil futures for July delivery fell 60 cents to $65.61 a barrel on the New York Mercantile Exchange.

Overseas, China’s benchmark Shanghai Composite Index rebounded 2.6 percent after plummeting 8.3 percent a day earlier. Japan’s Nikkei 225 index rose 0.45 percent. Britain’s FTSE 100 fell 0.47 percent, Germany’s DAX index dropped 0.71 percent, and France’s CAC-40 decreased 0.77 percent.

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