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Putting the U.S. on negative watch, S&P warned that it could cut the rating as soon as this month if talks between the White House and Republicans remain stalemated. Any cut would be by one or more notches, it added.

The dollar fell on the news. U.S. Treasuries were largely steady.

John Chambers, the chairman of S&P's sovereign ratings committee, said "this is the time" for the two sides to tackle the country's long-term debt problems.

"If you get a small agreement, that will lead to a downgrade," he told Reuters in an interview.

A downgrade could raise borrowing costs not only for the United States but also for loans that use the Treasury rate as a benchmark.

Some money managers that are restricted to investing only in AAA-rated assets would be forced to dump Treasuries, which could spread disruption through global financial markets.

The S&P warning comes just a day after Moody's Investors Service warned the U.S. may lose its top-notch credit rating in the next few weeks if lawmakers fail to increase the country's legal borrowing limit of $14.3 trillion and the government misses debt payments.

The deadline to raise the ceiling is on August 2.

"Today's CreditWatch placement signals our view that, owing to the dynamics of the political debate on the debt ceiling, there is at least a one-in-two likelihood that we could lower the long-term rating on the U.S. within the next 90 days," the agency said in a statement.

"We have also placed our short-term rating on the U.S. on CreditWatch negative, reflecting our view that the current situation presents such significant uncertainty to the U.S.' creditworthiness," S&P said.

"Further delays in raising the debt ceiling could lead us to conclude that a default is more possible than we previously thought. If so, we could lower the long-term rating on U.S. government this month," S&P said.

U.S. Treasuries reaction was generally muted, perhaps because Moody's had already raised the possibility of a downgrade. Dealers said the market might also be hoping that the pressure from the agencies would jolt U.S. lawmakers into reaching a deal.

As a result, Treasury prices dipped only modestly, lifting 10-year yields to 2.97 percent from 2.92 percent late in New York on Thursday.

The dollar fell against the euro to a session low of $1.42 before pulling back a bit to $1.4180. Dealers said the market was wary of buying the euro ahead of the results of Europe-wide stress tests on 90 banks due later Friday which could force some to seek state aid.

"Markets won't be able to shrug this off completely," said Adrian Foster, head of financial markets research for Asia Pacific at Rabobank International in Hong Kong.

"But the United States is in a different position from other countries. This is not some fiscal reform program that they have to put in place. This is just political machinations.

"It has less of a market impact, because we're programed to think the political machine will come through at the end of the day."

So protracted has been the wrangling over the budget that S&P warned that even if there was a deal done on raising the ceiling, it might still cut the rating if it was not convinced the agreement went far enough to address medium-term debt strains.

"If an agreement is reached, but we do not believe that it likely will stabilize the U.S.' debt dynamics, we, again all other things unchanged, would expect to lower the long-term 'AAA' rating, affirm the 'A-1+' short-term rating, and assign a negative outlook on the long-term rating," said S&P.

The S&P statement showed the need for Congress to act to raise the debt limit, Jeffrey Goldstein, the U.S. Treasury's under secretary for domestic finance, said in a statement.

"Congress must act expeditiously to avoid defaulting on the country's obligations and to enact a credible deficit reduction plan that commands bipartisan support," he said.

(Additional reporting by Walter Brandimarte in New York and Reuters bureaus in Asia; Editing by Balazs Koranyi and Neil Fullick)

Google's profit also topped forecasts in a quarter that showed the company is powering ahead in areas outside of its dominant Internet search business, including mobile and online video. The next challenge is whether it can duplicate that success in social networking.

Executives told analysts on a conference call the company had signed up more than 10 million people for Google+: the company's biggest foray into the hot social networking arena and the vanguard of its battle with Facebook and Twitter for websurfers' time and attention.

Over 135 million Android smartphones or tablets -- made by the likes of Motorola and Samsung Electronics -- had been activated in total. And its Chrome browser is now employed by more than 160 million users, CEO Larry Page said.

Shares of Google were up 12.3 percent at $594.50 in after-market trading, or just a whisker above levels at which the stock began 2011.

"Google should be viewed as a growth company again this quarter," said Stifel Nicolaus analyst Jordan Rohan. "The combination of mobile search, Android, ad exchange, YouTube, and the core search businesses, they're all doing well. Google is no longer a one trick pony."

"The number to focus on is really the GAAP earnings number. Google spent aggressively, hiring just as many people this quarter as they did last quarter."

Investors had feared Google's ever-increasing spending would eat into margins. Operating expenses leapt 49 percent to $2.97 billion in the second quarter, to about a third of revenue.

Analysts said the big increase in sales more than compensated for the rise in costs, but Google might find it increasingly difficult to shore up margins while it continues to hire, acquire and invest.

"Revenue growth overrides the hiring and the expense issues," BGC Partners analyst Colin Gillis said in response to the share price jump.

"Nice quarter from the guys, but you still have a situation of declining margins," he added.

PROFLIGATE SPENDING?

However, Page said the company may now be "a little ahead of where we need to be with headcount growth." Google had 28,768 employees as of the end of June 30.

Net income in the second quarter climbed to $2.51 billion, or $7.68 a share, from $1.84 billion, or $5.71 a share, in the year-ago period.

Excluding certain items, it earned $8.74 a share, ahead of analysts' average expectations of $7.85 a share.

Net revenue, which excludes fees paid to partner websites, jumped 36 percent to $6.92 billion, ahead of the $6.55 billion expected by analysts polled by Thomson Reuters I/B/E/S.

Co-founder Page is expected to face questions on Thursday regarding its spending and margins, and will be under pressure to make a better impression than he did during last quarter's post-earnings briefing. On that call, the man who founded Google with Sergey Brin annoyed participants after he came on the conference call, said a few words, then abruptly left.

Before the earnings, some analysts had argued that the launch of Google+ may take some of the heat off the company for its spending and make Wall Street more comfortable with Page, who took the CEO reins in April.

"We're still in the very early stages of what we want to do," Page said. "Our emerging ... products can generate huge new businesses for Google in the long run, just like search. And we have tons of experience monetizing products over time."

Investors are hungry also for details about an investigation by the U.S. Federal Trade Commission into Google's business practices as well as any commentary about how the European debt crisis is affecting its advertising business.

(Additional reporting by Mary Slosson in Los Angeles and Bill Rigby in Seattle; Writing by Edwin Chan; Editing by Richard Chang)

Other data on Thursday showed wholesale inflation ebbed last month for the first time in a year as energy prices fell, which could help to boost consumer spending.

Total retail sales rose 0.1 percent as a rebound in receipts from auto dealers offset the biggest drop in gasoline sales in a year, the Commerce Department said, after a dipping 0.1 percent in May.

Economists polled by Reuters had forecast sales slipping 0.1 percent. Sales excluding gasoline rebounded 0.3 percent after declining 0.2 percent in May.

A separate report from the Labor Department showed initial claims for state unemployment benefits fell 22,000 to 405,000 last week, below economists' expectations for a reading of 415,000.

"Underlying consumer spending hasn't slowed in three months, but it hasn't gotten any stronger," said Cary Leahey, economist at Decision Economics in New York.

U.S. stock index futures briefly extended gains on the data, and prices for government debt fell slightly.

The reports, coming on the heels of a data showing employers added only 18,000 jobs in June, were a mild boost for the economy, which has struggled to pull out of a soft-patch it hit as the year started.

Federal Reserve Chairman Ben Bernanke said on Wednesday the U.S. central bank, which ended a $600 billion government bond-buying program in June, was ready to ease monetary policy further if growth and inflation slowed much more.

The economy has been hurt by high commodity prices and disruptions to motor vehicle production in the aftermath of the March earthquake in Japan.

The retail sales report suggested that growth in consumer spending in the April-June period would be less than the 2.2 percent annual pace in the first quarter.

But the drop in gasoline prices from their peak just above $4.00 a gallon in May should help to ease the burden on stretched household budgets and support spending in coming months.

WHOLESALE PRICES FALL

Prices received by U.S. producer prices in June posted the steepest decline since February 2010. The Producer Price Index slumped 0.4 percent, the Labor Department said in a second report, twice as fast as expected, following a 0.2 percent rise in May.

Last month, sales at service stations dropped 1.3 percent, the largest decline since June last year, reflecting a 22.5 cents drop in prices at the pump in June.

That decline was mitigated by a 0.8 percent bounce back in motor vehicle sales, indicating an easing in shortages related to supply chain disruptions from Japan. Motor vehicle sales declined 1.8 percent in May.

Excluding autos, retail sales were flat last month, the weakest reading since last July, after rising 0.2 percent in May.

Details of the report were generally mixed, with clothing store receipts rising 0.7 percent last month. Sales at building materials and garden equipment suppliers increased 1.3 percent.

But receipts at sporting goods, hobby, book and music stores fell 0.7 percent, while sales of electronics and appliances dipped 0.2 percent.

Core retail sales -- excluding autos, gasoline and building materials -- edged up 0.1 percent in June after gaining 0.1 percent the prior month.

Core sales correspond most closely with the consumer spending component of the government's gross domestic product report.

(Reporting by Lucia Mutikani and Pedro Nicolaci da Costa; Editing by Neil Stempleman)

* Wall Street will pay more attention to JPMorgan (JPM.N) forecasts, looking for clues on the direction of the U.S. lending business. Analysts expect the firm's earnings per share to rise to $1.21 in the second quarter from $1.09 a year ago.

* Also reporting results, Google (GOOG.O) is expected to report a rise in earnings per share to $0.71 from $0.68 a year earlier. Its newly released social networking service, dubbed Google+ will be in the spotlight.

* S&P 500 futures fell 1.1 points and were below fair value, a formula that evaluates pricing by taking into account interest rates, dividends and time to expiration on the contract. Dow Jones industrial average futures fell 9 points, and Nasdaq 100 futures added 8.5 points.

"JP Morgan is going to set an opening tone for the financials, particularly should they disappoint, because it's considered by many the strongest and their inability to meet even lowered expectations could impact the whole sector," said Rick Meckler, president of investment firm LibertyView Capital Management.

* After markets closed on Wednesday, ratings agency Moody's warned that the United States could lose its top credit rating if lawmakers fail to increase the country's borrowing limit, sending U.S. stock index futures sharply lower.

* Moody's said it would likely assign a negative outlook to the nation's gold-plated credit rating if a credible agreement with long-term deficit reduction measures was not achieved.

* President Barack Obama clashed with Republican lawmakers on Wednesday in a fierce White House meeting on deficit reduction that left a deal in question as the clock ticked toward a debt default.

* In Europe, the pan-European FTSEurofirst 300 .FTEU3 index of top shares fell 1 percent in early trade, on the back of Moody's warning on the credit rating of the United States.

(Editing by Kenneth Barry)