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U.S. Federal Reserve chairman Ben Bernanke repeated predictions that the American economy will grow by 3.5 per cent in 2010.

North American markets gave back earlier gains Wednesday despite comments from U.S. Federal Reserve chairman Ben Bernanke that the effect of the European debt crisis on the American economic recovery is likely to be only "modest." 

Speaking to the U.S. House budget committee, Bernanke predicted that even with stubbornly high unemployment and a fragile housing market, the recovery will remain intact as long as Wall Street stabilizes.

Initially, markets rose, but after the close of trading in Europe, the euro again slipped below $1.20 US on renewed fears that deficit-fighting spending cuts will mean a reduction in stimulus spending and affect the global recovery. Late Wednesday the euro was trading at $1.1984 US.

A selloff in shares of BP, as traders worried about the costs it will have to bear from the oil spill in the Gulf of Mexico, also pulled the New York Stock Exchange lower. BP fell almost 16 per cent to $29.20 US.

In Toronto, the S&P/TSX composite index lost 66.5 points to close at 11,450.64. In New York, the Dow Jones industrials average lost 40.73 to end at 9,899.25, the Standard & Poor's 500 index was down 6.30 to 1,055.70, and the Nasdaq composite index was off 11.72 to 2158.85.

Bernanke said the Fed stands by its earlier prediction that the U.S. economy will grow by 3.5 per cent in 2010.

The Federal Reserve also released its closely watched Beige Book on Wednesday.

Recovery now across all parts of US

The survey of economic conditions across the U.S. showed the recovery is finally spreading to all parts of the country, but the modest pace likely means job creation will be slow.

In the new survey, manufacturing picked up, retail sales grew, tourism improved and housing was helped by the now-expired tax credit for homebuyers. But commercial real estate is weak and labour market conditions improved only "slightly."

"The pace of economic improvement seems painfully slow," BMO Capital Markets senior economist Jennifer Lee said in a commentary, something echoed by Alistair Bentley, a research analyst at TD Economics.

Bentley said the fact the Beige Book found that American banks are still being conservative in their lending policies is a major reason he is predicting U.S. economic growth of 3.2 and 2.8 per cent in 2010 and 2011, respectively.

Action needed on deficit

Bernanke repeated warnings that measures will be needed to reduce the U.S. budget deficit, projected to reach a record $1.6 trillion in 2011-12, or 10.6 per cent of gross domestic product. That would be its highest level since the Second World War.

He said Europe's debt crisis shows why it's important to keep government spending under control.

"To avoid sharp, disruptive shifts in spending programs and tax policies in the future, and to retain the confidence of the public and the markets, we should be planning now how we will meet these looming budgetary challenges," Bernanke said.

With files from The Associated Press