(Updates prices, adds Wall Street outlook)

By Ana Nicolaci da Costa

LONDON, Jan 11 (Reuters) - European stocks fell to their lowest level in over a year and two-year U.S. bond yields eased to a three-year low on Friday as a newspaper report that Merrill Lynch would suffer worse-than-expected write-offs unnerved markets.

Wall Street <DJc1> <SPc1> <NDc1> also braced for a lower open after the New York Times said Merrill is expected to suffer $15 billion in losses from soured mortgage investments, news that came on the heels of a profit warning by American Express <AXP.N>.

Worries over the credit market inspired investors to shun the dollar in favour of the yen, with the greenback falling 0.4 percent against the Japanese currency <JPY=>.

The FTSEurofirst 300 index <.FTEU3>, already under pressure in the previous session as both the European Central Bank and the Bank of England kept rates on hold, was down 0.5 percent.

Stocks' weakness also came despite news that Bank of America had agreed to acquire struggling mortgage lender Countrywide Financial <CFC.N> for about $4 billion in stock, a move that could help avert one of the biggest collapses in the U.S. housing crisis.

Earlier, Japan's benchmark Nikkei <.N225> fell to its lowest close since Nov. 2005.

"We've probably seen write-offs of a quarter to a third of the total of what we're likely to get, and the key for markets in the course of 2008 will be the frequency with which this news hits the market and the magnitude of the losses," said Commerzbank economist Peter Dixon.

In Europe, UBS <UBSN.VX> said it could not predict how the subprime crisis would play out but said it had appealed to its shareholders to back a capital injection by the Singapore government and a Middle East investor.

BERNANKE OVERSHADOWED

Credit worries thus overshadowed comments from the Federal Reserve Chairman Ben Bernanke on Thursday acknowledging the U.S. economy faced increased risks and indicating the Fed was ready to cut interest rates aggressively to support growth.

But in saying this, Bernanke did fuel hopes for more aggressive U.S. rate cuts, helping to drive gold to a fresh record high near $900 an ounce.

A credit crisis originating in troubles in the risky U.S. subprime mortgage market shook financial assets last year making it the FTSEurofirst 300 index's worst performance since 2002, even if it ended the year up 1.6 percent.

The possibility of more financial trouble, ahead of key results in the U.S. banking sector next week, also kept assets traditionally seen as safe-haven underpinned.

The yen was up 0.6 percent against the euro <EURJPY=> while the Swiss franc traded up 0.2 percent against the euro <EURCHF=>.

As well as Merrill, big names such as Citigroup <C.N>, State Street <STT.N>, US Bancorp <USB.N> and JP Morgan <JPM.N> report results next week.

Investors will be looking closely at the results to see how the recently downbeat sector is faring especially as recent data, such as last week's key U.S. jobs data, has fuelled fears the world's largest economy may be on the brink of recession.

Such concerns have even knocked oil prices off last week's record highs of just above $100 a barrel. U.S. crude last traded at $93.16 a barrel.

Weakness in consumer sentiment numbers globally and some disappointing figures from retailers have also fuelled concerns over the impact of the credit crisis on the real economy.

Some analysts say the only solution is further rate cuts but even Bernanke's comments weren't enough to comfort nervous investors.

"While Bernanke appeared to be in generous mood in terms of prospects for cutting rates, market psyche is such at present that the general take is that his turnaround must suggest that he knows something that we all don't, i.e. that the U.S. economy is in much worse shape than we have all been hitherto assuming," said Bear Stearns in a client note. (Editing by Ron Askew) (([email protected]; Reuters Messaging: [email protected]; +4420 7542 2575))

Keywords: MARKETS GLOBAL