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Odds of 50 bps rate hike jump dramatically

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Powell says Fed likely needs to raise rates higher

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Indexes down: Dow 1.66%, S&P 1.53%, Nasdaq 1.17%

March 7 (Reuters) - U.S. stock indexes fell on Tuesday after Federal Reserve Chair Jerome Powell told Congress the central bank will likely need to raise interest rates more than expected as it seeks to rein in stubbornly high inflation.

Equities lost ground right after Powell's prepared remarks were released ahead of his testimony and sank further as the session wore on. Powell told U.S. lawmakers the Fed is prepared to move in larger steps if economic data suggests tougher measures are needed to control rising prices.

The remarks were his first since data showed inflation unexpectedly jumped in January and the U.S. government reported an unusually large increase in payroll jobs for the month.

Traders dramatically raised their bets of a 50-basis-point rate hike in March after Powell's comments, with money market futures pricing a more than 65% chance of such a move, up from 31% before the remarks, according to CME Group's FedWatch tool.

The idea of higher rates for longer is a headwind and "hearing it directly from Powell is a little different to inferring it from the data," said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance.

But some money managers say investors should have been expecting Powell's hawkish tone.

"The bear market rally that began in October has been supported by hope over reality. Fed Chair Powell's comments today should come as no surprise to investors," said John Lynch, chief investment officer for Comerica Wealth Management, in an email.

"Employment and consumption have been strong, while the easy gains in the battle against inflation have been made."

The Dow Jones Industrial Average fell 559.16 points, or 1.67%, to 32,872.28, the S&P 500 lost 61.78 points, or 1.53%, to 3,986.64 and the Nasdaq Composite dropped 136.86 points, or 1.17%, to 11,538.88.

All 11 major S&P sectors were in the red, led by economically sensitive financials with a 2.5% drop. Declining least was the consumer discretionary index, down 0.99%.

Powell, who will testify again on Wednesday before the House of Representatives Financial Services Committee, also added that the Fed will not consider changing its 2% inflation target and the job market does not suggest an economic downturn was close.

Data the Fed will use to influence its rate hiking path will include Friday's non-farm payroll numbers. Economists polled by Reuters are expecting an increase of 200,000 jobs in February, compared with the much stronger-than-expected 517,000 jobs reported in January.

"A 50 bps hike in the next meeting is possible, but it is going to be dependent on the payrolls not slowing down and CPI numbers showing that the disinflation progress we've made is stalling," said Scott Ladner, chief investment officer at Horizon Investments.

Meanwhile, the yield on two-year Treasury notes, which best reflects short-term rate expectations, hit 5% for the first time since July 2007.

Rising bond yields tend to weigh on equity valuations, particularly those of growth and technology stocks, as higher rates reduce the value of future cash flows.

Big individual stock moves included a 12% decline for Rivian Automotive after the electric automaker unveiled plans to sell bonds worth $1.3 billion.

Dick's Sporting Goods was up 9.6% after the retailer forecast annual earnings above Wall Street estimates and more than doubled its quarterly dividend.

Declining issues outnumbered advancers on the NYSE by a 3.71-to-1 ratio; on Nasdaq, a 2.13-to-1 ratio favored decliners.

The S&P 500 posted 10 new 52-week highs and seven new lows; the Nasdaq Composite recorded 45 new highs and 122 new lows.

(Reporting by Sinéad Carew in New York, Sruthi Shankar and Bansari Mayur Kamdar in Bengaluru, graphic by Noel Randewich in San Francisco, additional reporting by Ankika Biswas by Shristi Achar A Editing by Vinay Dwivedi and Richard Chang)