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"Beyond a certain point ... the United States would be forced into a position of defaulting on its debt. And the implications of that on our financial system, our fiscal policy and our economy would be catastrophic," he told the National Press Club.

Bernanke coupled his warning with a call for the Obama administration and Congress to put in place a credible plan to curb future budget deficits.

He also offered a moderately more optimistic assessment of the economy's prospects than in other recent remarks, although he made clear the recovery still needs support from the Fed.

Some Republican leaders intend to use the need to raise the statutory debt ceiling as leverage for spending cuts. The Obama administration has said the nation would likely hit the limit between early April and late May.

If Congress does not raise the limit in a timely way, the government could be forced to scale back operations. A failure to lift the limit could raise the specter of a first-ever U.S. debt default and push interest rates up sharply.

Financial markets have not yet shown any nervousness over the debt limit, which has typically been raised after political grumbling, and Bernanke said the chances of a default were "very remote."

Still, his comments echoed dire warnings issued by Treasury Secretary Timothy Geithner and other Obama administration officials, who have also said failure to raise the debt ceiling could be "catastrophic."

The Fed chairman called on lawmakers not to hold the issue hostage to the contentious debate over how best to rein in record budget gaps.

"I would very much urge Congress not to focus on the debt limit as being the bargaining chip in this discussion, but rather to address directly the spending and tax issues that we have to deal with in order to make progress on this fiscal situation," Bernanke said.

FED MISSING BOTH MANDATE TARGETS

In discussing the recovery, Bernanke provided a modestly more rosy outlook than he has in other recent appearances, citing gains in household spending, improved consumer and business confidence and stepped-up bank lending as signs 2011 may bring stronger growth than 2010.

But he made clear Fed officials were not yet satisfied.

"Although economic growth will probably increase this year, we expect the unemployment rate to remain stubbornly above, and inflation to remain stubbornly below, the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our mandate," he said.

Bernanke's comments on the economy suggest the Fed believes it has plenty of time to let its policies boost growth and pull down a high unemployment rate before it needs to worry about tightening financial conditions to keep inflation in check.

While there are signs that the global economy is gaining momentum, many market players were on the sidelines, eyeing developments in Egypt after the White House was said to be discussing the immediate resignation of Hosni Mubarak as one of several scenarios for a transition of power.

The U.S. move comes after 10 days of anti-government protests in Egypt and ahead of a mass "Day of Departure" rally planned by protesters in Cairo's Tahrir Square on Friday to force Mubarak to quit.

Clashes between pro- and anti-Mubarak demonstrators have fueled fears of possible disruptions to energy supplies and boosted crude oil prices, which were headed for a second straight week of gains.

Brent crude for March gained 31 cents on Friday to $102.07 a barrel at 0525 GMT, after touching $103.37 on Thursday, the highest intraday price since September 26 2008, and then sliding on a stronger dollar. U.S. crude rose 39 cents to $90.93.

Japan's Nikkei .N225 shares gained 1.1 percent, lifted by steelmakers which surged on news of a mega merger in the sector that would create the world's No.2 steel producer.

Tough competition from steelmakers in China and India, shrinking demand from domestic automakers and rising prices for raw materials such as coal and iron ore prompted the deal which would likely see Nippon Steel acquiring Sumitomo Metal, valued at $11 billion.

Shares of Nippon Steel (5401.T) and Sumitomo Metal 5405..T rallied sharply, rising 9 percent and 16 percent, respectively.

"The news will likely raise expectations that more Japanese companies will seriously try to increase their competitive edge in the global market," said Shinichiro Matsushita, a senior market analyst at Daiwa Securities.

"On top of last week's NEC-Lenovo deal, these deals will boost investor sentiment toward Japanese stocks."

The Nikkei has risen 3.1 percent so far this year and is Asia's top performing market as investors continue to favor developed markets over emerging markets that are battling with high inflation and political risk. The MSCI Asia ex-Japan index .MIAPJ0000PUS is up just 0.6 percent.

Australia's key stock index .AXJO rose 0.9 percent as heavyweighted commodity-related stocks rallied. Most other markets in Asia remained shut for the Lunar New Year holidays and will reopen on Monday.

Spurred by further signs that the global economic recovery is gaining traction and speculative buying, copper hit $10,000 a tonne for the first time in London overnight, before easing slightly. Sugar retreated as well after spiking to 30-year tops on Wednesday as a killer cyclone battered Australia's sugar cane fields. Wheat rebounded after a brief decline, staying near the 2008 highs seen in the last session after a snowstorm that paralyzed the U.S. grain belt.

Surging food prices have come back into the spotlight after they helped fuel the discontent that toppled Tunisia's president in January and spilled over to Egypt and Jordan.

Global food prices tracked by a U.N. agency hit their highest level on record in January.

The government is expected to report on Friday that nonfarm payrolls grew 145,000, according to a Reuters survey, after adding 103,000 in December. But severe snow storms that slammed large parts of the nation could result in a much lower figure.

All of the anticipated job gains are expected to have been generated by the private sector and would add to other data suggesting that the manufacturing-driven recovery is now spreading to other sectors of the economy.

The Labor Department will release its closely watched employment report at 8:30 a.m. (1330 GMT)

"All the signals are pointing to a much improved labor market compared with last year and a strong payrolls report would be a nice confirmation that things are certainly headed in the right direction," said Omair Sharif, an economist at RBS in Stamford, Connecticut.

Still, the employment gains would be insufficient to prevent the jobless rate from edging up to 9.5 percent from 9.4 percent in November and too slim to discourage the Federal Reserve from completing its $600 billion government bond-buying program to support the economy.

The labor market has lagged the broader economy, which grew at a 3.2 percent annual rate in the fourth quarter. Fed Chairman Ben Bernanke on Thursday acknowledged the pick-up in the recovery, but said "it will be several years before the unemployment rate has returned to a more normal level."

WEATHER COULD DAMPEN PAYROLLS

Economists believe the weather could have restrained payroll growth by 15,000 to 70,000 positions in January, although the way in which the government conducts its count could temper any storm-related impact.

For severe weather to reduce the payroll count, employees have to be off work for the entire reference pay period and not paid for the time missed. Workers who receive any pay, even if just for one hour, during the pay period that includes January 12 would be counted as employed.

"My view is that the storms interrupted the hiring process. They have not diminished the demand for labor, but made it that much more difficult for both the job seekers and employers to consummate the hiring transaction," said Patrick O'Keefe, head of economic research at J.H. Cohn in Roseland, New Jersey.

The jobless rate dropped sharply in December, but that partly reflected discouraged workers leaving the labor force. Economists viewed the decline as overstated and expect it rose a touch in January.

Further increases could be in store in the months ahead as the labor market gains strength, which could spur some discouraged workers to come back into the labor force.

"We have a lot of workers on the sidelines. They will come back it when the labor market recovers," said Stephen Bronars, senior economist at Welch Consulting in Washington. "The effect is that the unemployment rate is going to stay above a level we would consider acceptable for a longer period of time."

A persistently high unemployment rate could put in jeopardy President Barack Obama's chances of winning a second-term in office in the 2012 election.

"Beyond a certain point ... the United States would be forced into a position of defaulting on its debt. And the implications of that on our financial system, our fiscal policy and our economy would be catastrophic," he told the National Press Club.

Bernanke coupled his warning with a call for the Obama administration and Congress to put in place a credible plan to curb future budget deficits.

He also offered a moderately more optimistic assessment of the economy's prospects than in other recent remarks, although he made clear the recovery still needs support from the Fed.

Some Republican leaders intend to use the need to raise the statutory debt ceiling as leverage for spending cuts. The Obama administration has said the nation would likely hit the limit between early April and late May.

If Congress does not raise the limit in a timely way, the government could be forced to scale back operations. A failure to lift the limit could raise the specter of a first-ever U.S. debt default and push interest rates up sharply.

Financial markets have not yet shown any nervousness over the debt limit, which has typically been raised after political grumbling, and Bernanke said the chances of a default were "very remote."

Still, his comments echoed dire warnings issued by Treasury Secretary Timothy Geithner and other Obama administration officials, who have also said failure to raise the debt ceiling could be "catastrophic."

The Fed chairman called on lawmakers not to hold the issue hostage to the contentious debate over how best to rein in record budget gaps.

"I would very much urge Congress not to focus on the debt limit as being the bargaining chip in this discussion, but rather to address directly the spending and tax issues that we have to deal with in order to make progress on this fiscal situation," Bernanke said.

FED MISSING BOTH MANDATE TARGETS

In discussing the recovery, Bernanke provided a modestly more rosy outlook than he has in other recent appearances, citing gains in household spending, improved consumer and business confidence and stepped-up bank lending as signs 2011 may bring stronger growth than 2010.

But he made clear Fed officials were not yet satisfied.

"Although economic growth will probably increase this year, we expect the unemployment rate to remain stubbornly above, and inflation to remain stubbornly below, the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our mandate," he said.

Bernanke's comments on the economy suggest the Fed believes it has plenty of time to let its policies boost growth and pull down a high unemployment rate before it needs to worry about tightening financial conditions to keep inflation in check.

The Morgan Stanley retail index .MVR rose 2.8 percent, driven by companies such as Sears Holdings Corp (SHLD.O), up almost 8 percent, and Ross Stores Inc (ROST.O), up 6 percent and at a new high.

U.S. chain-store sales climbed 4.8 percent in January. Along with rising service-sector activity and improved jobless claims figures, the stronger-than-expected retail figures added to growing evidence of an economic rebound.

"The strength in the retail sector is probably the standout feature today," said Nick Kalivas, an analyst at MF Global in Chicago. "You have generally a profit-taking, consolidative market after a couple of days of big run-ups (and) in front of the employment report tomorrow."

The wider market had come under pressure for most of the day as some investors said stocks were extended after weeks of gains, while a stronger dollar weighed on the natural resource sector.

Kalivas said the material and energy sectors were ripe for profit-taking while retail stocks had lagged the rally since the beginning of the year over concerns about the strength of consumer spending.

The Dow Jones industrial average .DJI gained 20.29 points, or 0.17 percent, to 12,062.26. The Standard & Poor's 500 Index .SPX rose 3.07 points, or 0.24 percent, to 1,307.10. The Nasdaq Composite Index .IXIC added 4.32 points, or 0.16 percent, to 2,753.88.

The S&P 500 has rallied more than 10 percent since breaking out of a trading range at the start of December and is up 21 percent since the end of August.

Data showed the U.S. services sector grew in January at its fastest pace since August 2005, and initial claims in the latest week for state unemployment benefits fell more than expected.

The S&P's energy sector .GSPE has been the top gainer this year, rallying 9.4 percent, while industrials .GSPI and technology .GSPT each have rallied 6 percent. Over that time the Morgan Stanley retail index has fallen 2.5 percent.

The strong performance in retail shares comes ahead of Friday's employment report that is expected to show the U.S. economy added 145,000 jobs in January.

Also in the retail sector BJ's Wholesale Club Inc (BJ.N) said it may put itself up for sale. Shares of BJ's, which is under pressure from a private equity firm that may make a hostile bid, jumped 12.2 percent to $48.25.

Clashes continued in Egypt, adding to concern that has pressured equities recently.

Merck & Co (MRK.N) fell 2.7 percent to $32.90 and was the top drag on the Dow after the drugmaker forecast 2011 earnings below Wall Street forecasts and withdrew its longer-term profit view.

Trading volume was 7.69 billion shares on the New York Stock Exchange, the American Stock Exchange and Nasdaq, down from last year's estimated daily average of 8.47 billion shares.

Advancing stocks outnumbered declining ones on the NYSE by almost 5 to 4. On the Nasdaq, decliners came in marginally ahead of be advancers.

(Editing by Kenneth Barry)