World stocks take a breather, eye U.S. stress tests

By Al Yoon

NEW YORK (Reuters) - World stocks paused on Tuesday after reaching their highest levels in nearly four months as renewed concern over banks' capital dampened enthusiasm that the financial crisis and economic slowdown are abating.

The U.S. dollar rebounded from a one-month low versus the euro, amid worries over the banking sector and investors booked profits ahead of a European Central Bank meeting on Thursday.

European shares were mixed and U.S. stocks dipped as falling oil prices hit energy shares and investors anticipated results from regulator capital tests at U.S. banks. About 10 of the 19 largest U.S. banks being "stress tested" will likely be told they must raise capital, according to a source familiar with the talks.

Most banks undergoing the test will likely report results to shareholders on Friday, Jamie Dimon, chief executive officer of JPMorgan Chase & Co., said at a news conference.

The tests aim to ensure bank stability should the recession drag on, placing further pressure on their balance sheets laden with risky consumer and commercial loans. But there are also signs that the economy and financial markets have stabilized since last fall could fuel a broader rally, and break momentum of profit-taking moves such as today's, investors said.

A report on the U.S. service economy said an index of the sector rose more than expected in April to 43.7 from 40.8, closer to the 50 level that denotes equilibrium between contraction and expansion.

"We've had a great run -- and I don't think the run is over -- but it will take a while to undo some of the damage that has been done over the past year or two," said Charles Lieberman, chief investment officer at Advisors Capital Management LLC, in Paramus, New Jersey. "We're in a convalescence period."

Federal Reserve Chairman Ben Bernanke on Tuesday said markets were in "far better shape" today than last fall, helped by the Treasury program to inject up to $700 billion in capital to U.S. financial institutions and auto makers.