New York/Washington - US stocks made strong gains after a wild day of trading Tuesday, pulling back from the worst day on Wall Street since the September 2001 terrorist attacks.

The Dow Jones Industrial Average rose 1.3 per cent, largely on investors' hopes that the government would come to the rescue of American International Group Inc (AIG), the largest US insurer. The broader Standard & Poor's 500 Index surged 1.75 per cent.

AIG has been in discussions since Monday to secure temporary financing of as much as 75 billion dollars from government or private sources, or it may be forced into bankruptcy as early as Wednesday. There was no official word on the progress by Tuesday afternoon, but media reports said the Federal Reserve was considering making the loan.

Speculation about the outcome of the talks caused much of the up- and-down on Wall Street. Major indices in New York moved between losses and gains more than 25 times over the trading day, according to Bloomberg financial news service.

The Dow had plunged more than 500 points, or 4.4 per cent, and the S&P 500 tumbled 4.7 per cent on Monday, after investment bank Lehman Brothers Holdings Inc filed the largest bankruptcy in US history. The Dow opened 150 points lower Tuesday morning before paring the early losses.

Lehman's bankruptcy and AIG's scramble for cash were only some of the stories stoking fears in investors about the viability of US financial firms amid an ongoing credit crisis that has decimated the value of mortgage-backed securities.

The financial turmoil had led some economists to speculate that the Federal Reserve would lower interest rates.

But in a unanimous decision Tuesday, the US central bank left its benchmark federal funds rate steady at 2 per cent, citing both growth and inflation risks.

The Federal Open Market Committee acknowledged that "strains in financial markets have increased significantly" and cited credit conditions and the ongoing housing crisis as continuing drags on the world's largest economy.

But the Fed also warned that inflation remained of "significant concern."

The government earlier reported consumer prices dropped 0.1 per cent from July to August on a seasonally adjusted basis, the first monthly drop in two years. The consumer price index rose 5.4 per cent year-on-year in August, down from a 5.6-per-cent inflation rate in July.

On Tuesday the Dow rose 141.51 points to 11,059.02. The S&P 500 was up 20.90 points to 1,213.60. The technology-heavy Nasdaq Composite Index climbed 27.99 points, or 1.28 per cent, to 2,207.90.

The US currency rose to 70.68 euro cents from 70.13 euro cents on Monday. The dollar climbed against the Japanese currency to 105.82 yen from 104.86 on Monday.

Even financial stocks made gains on Tuesday, led by Merrill Lynch & Co, which was acquired by Bank of America Corp late Sunday.

The Federal Reserve said it would continue to monitor economic growth and left the door open for more emergency lending to boost liquidity in the financial sector.

The central bank has injected 120 billion dollars of reserves into the banking sector over the past two days, and on Sunday widened the type of securities it will accept as collateral for the emergency loans.

All eyes remained on AIG, whose credit ratings were downgraded by S&P and Moody's Investors Service earlier Tuesday. New York Governor David Patterson said the insurance giant had one day left to make a deal that would boost its liquidity.

Bloomberg and US financial broadcaster CNBC reported the Fed was considering providing the bridge loan AIG needed after pressure from New York policymakers. The Fed had been pushing for a private solution, but that had reportedly become untenable.

AIG's share price fell as much as 70 per cent in early trading before recovering most of the losses. The company's shares plunged 60 per cent on Monday.

Also Tuesday, the largest US investment bank Goldman Sachs Group Inc reported third-quarter profits dropped 70 per cent to 845 million dollars, but stressed the company remained "well-positioned" and was doing better than its competitors.

Morgan Stanley, the second-largest US investment bank, reported third-quarter profit fell 3 per cent to 1.43 billion dollars, less than forecast by economists.