Bank stocks rebounded Thursday as falling oil prices eased concern about inflation.

The KBW Bank Index rose 3.2% after falling 4.1% Wednesday and 6.4% Tuesday.

Financials helped lift the broader markets. The Dow Jones industrial average rose 0.7% and the Standard & Poor's 500 rose 0.6%.

Inflation soared by 5.6% from a year earlier in July, hitting a 17-year high because of high food and energy costs, the Labor Department said Thursday. But the data is from the first three weeks of the month and does not reflect a decline in prices of oil and, by extension, gasoline over the last week of July and in early August, economists said.

Crude oil prices, which had fluctuated this week, fell by $1 a barrel on Thursday, allowing investors to shake off the inflation report. Oil is down 21% from its record high last month.

The dollar made gains against other currencies Thursday as European and Asian economies show signs of slumping. Slower foreign economies, the thinking goes, should lead to a decline in global demand for fuel.

Richard J. DeKaser, chief economist at National City Corp., said in an interview Thursday that investors typically turn to commodities as a hedge against a weak dollar; when the greenback makes gains, he said, interest in commodities, most notably oil, often falls.

"What we are looking at is a prospective unwinding of inflation," Mr. DeKaser said. "And I think that's what caught the market's attention today."

The drop in oil prices reduced pressure on the Federal Reserve Board to raise interest rates, economists said, which was welcome news for the banking sector because many banks have offset mortgage losses by capitalizing on the lower cost of funds to boost their net interest margins.

That may have helped soften the impact of new home-foreclosure data. According to a RealtyTrac survey released Thursday, foreclosures jumped 55% in July from a year earlier. Foreclosure filings increased 8% from the previous month, affecting 272,171 properties.

Notable gainers Thursday included Wachovia Corp. of Charlotte, 6.8%; Huntington Bancshares Inc. of Columbus, Ohio, 9.6%; Downey Financial Corp. of Newport Beach, Calif., 14.6%; Sterling Financial Corp. of Spokane, 7.5%; and Century Bancorp Inc. in Medford, Mass., 17%.

Fannie Mae gained 7.7%, and Freddie Mac closed up 7%.

Banks stocks had taken a beating this week in part because of controversy surrounding the troubled auction-rate securities market. Regulators have charged that several banks misled investors about the risk involved with the market.

JPMorgan Chase & Co. and Morgan Stanley on Thursday became the latest in a string of companies to settle a dispute with the New York attorney general and other state regulators. JPMorgan Chase and Morgan Stanley will buy back a total of $7 billion in auction-rate securities from investors.

Investors on Thursday appeared to read the settlements as a sign that the controversy is winding down. JPMorgan Chase's shares rose 2.4%, and Morgan Stanley gained 1.2%. The KBW Bank Index, however, still is down 4.5% for the past week, and investment strategists said that, as long uncertainty in the credit markets hangs over banks' profit outlooks, trading in financial stocks is bound to be volatile.

"There is still plenty of uncertainty about what's to come," Myles Zyblock, the chief strategist at Royal Bank of Canada's RBC Capital Markets, said in an interview Thursday. "We still have a long workout period to get through."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.