* World stocks climb 2.5 percent
* Fed to buy $300 billion of long-dated Treasuries
* Dollar hits 2-month low, European credit spreads tighten
* Commodities up on hope of pick up in industrial activity
By Atul Prakash
LONDON, March 19 (Reuters) - The dollar hit a two-month low on Thursday after its biggest one-day fall in at least 25 years when the U.S. Federal Reserve announced it would buy long-dated debt, a move that also lifted stock markets sharply.
The Fed's action raised risks that a sharp expansion of the Fed's balance sheet, which has already doubled in the past six months, would eventually lead to oversupply of the world's main reserve currency.
U.S. Treasury yields fell and European credit spreads tightened, but the announcement also sparked optimism that the battered U.S. economy could soon begin to recover.
Share prices responded positively along with prices of crude oil and industrial metals.
The Federal Reserve said it would buy $300 billion of long-dated Treasuries over the next six months, its first large-scale purchases of government debt since the early 1960s, while also boosting buying of mortgage-backed securities and agency debt in its bid to rescue the economy.
It floated the idea of buying Treasuries some time ago but then seemed to go cold on the idea. The sudden change of direction took most investors completely by surprise. The move also effectively amounts to the Fed printing money -- and is hence bad news for the dollar.
The dollar index, a gauge of its performance against a basket of major currencies, fell 1.1 percent to 82.911 after a 3 percent slide on Wednesday -- its biggest one-day drop in at least a quarter of a century.
"It's all part of a global process of easing which is positive for risk assets in the short-term," said Nick Parsons, head of markets strategy at National Australia Bank.
"The one factor supporting the dollar over the last three months has been the woeful performance of equity markets and if this sees a lift in risk appetite ... that is absolutely, unequivocally negative for the dollar."
World shares jumped as investors moved away from the dollar to grab equities following the Fed announcement that sparked optimism the battered U.S. economy could soon begin to recover.
World stocks, as measured by MSCI's all country index climbed 2.5 percent to 202.31, while European shares rose 2.2 percent. U.S. stocks rallied overnight as investors bet the Fed's move would kick-start lending.
"The Fed is wheeling out the heavy artillery, demonstrating a clear desire to do the utmost to drive down borrowing costs and revive the economy, and confidence that the extreme measures taken will be reversible swiftly as and when needed," Barclays Wealth said in a note.
"This reinforces our view that the United States will be among the first to emerge from the recession, even if this will come at a cost of longer-term sub-par growth as economic rebalancing is slow."
CREDIT DEFAULT SWAPS TIGHTEN
Financial sector European credit default swap spreads tightened on the Fed move and after Swiss bank UBS announced a bond buy-back to boost its capital.
The investment-grade Markit iTraxx Europe index was at 186 basis points, according to data from Markit, 5 basis points tighter than late Wednesday. The Markit iTraxx Crossover index, made up of 50 mostly "junk"-rated credits, was at 1,126 basis points, 7 basis points tighter.
The U.S. is not alone in buying of government debt. The Bank of England is buying 75 billion pounds of gilts and the Bank of Japan on Wednesday announced it would increase its purchases of Japanese government debt.
The Swiss National Bank surprised markets last week with intervention to weaken the Swiss franc as well as an interest rate cut to fight a deep recession. The European Central Bank may also eventually turn to non-standard policy measures.
"We'll have to see how this pans out, but ultimately the Fed are printing paper, the UK are printing paper, the Swiss are printing paper, the Japanese are printing paper -- they are all at it and I don't want to buy those currencies," said David Bloom, global head of FX research at HSBC markets in London.
"I don't believe in the argument that its going to create economic growth and you will get portfolio flows -- forget it, they are sorting out a crisis," he added.
10-year U.S. Treasuries hovered near a two-month high, while commodity markets were cheered on a glimmer of hope that the Federal Reserve's move would revive the global economy, boost industrial activity and increase demand for oils and metals.
Oil prices jumped 6.3 percent to above $51 a barrel, copper climbed 2.9 percent and aluminium rose more than 2 percent.
Dollar weakness played into precious metals, sending gold prices to a two week high as it reprised its traditional relationship with the U.S. currency. (Additional reporting by Kirsten Donovan and Veronica Brown; Editing by Victoria Main)