* Bets for 50 bps March rate hike jump dramatically
* Powell says Fed likely needs to raise rates higher
* Indexes end down: Dow 1.72%, S&P 1.53%, Nasdaq 1.25%
March 7 (Reuters) - U.S. stock indexes closed sharply lower on Tuesday after Federal Reserve Chair Jerome Powell told Congress the central bank will likely need to raise interest rates more than previously expected as it seeks to rein in stubbornly high inflation.
Of Wall Street's three major indexes, the Dow Jones Industrial Average lost most ground with a 1.7% decline, while the S&P 500 fell 1.5% and the Nasdaq Composite lost almost 1.3%.
Powell sent stock investors fleeing when he told U.S. lawmakers earlier in the day that the Fed is prepared to hike rates in larger steps if future economic data suggests tougher measures are needed to control rising prices.
The remarks followed recent data showing an unexpected inflation increase in January and an unusually large jobs gain for the month.
Traders dramatically raised their bets for a 50-basis-point rate hike in March after Powell's comments, with money market futures last pricing in a more than 70% chance of such a move, up from around 31% on Monday, according to CME Group's FedWatch tool.
While many investors had worried that the Fed would consider higher rates for longer than previously expected, "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.
"From a risk-rewards standpoint investors have to recalculate their desire to be invested with this new paradigm," said Adam Sarhan, chief executive of 50 Park Investments, based in Orlando, Florida. "It's the realization the Fed is going to err on the side of being more hawkish."
The Dow Jones Industrial Average fell 574.98 points, or 1.72%, to 32,856.46; the S&P 500 lost 62.05 points, or 1.53%, at 3,986.37; and the Nasdaq Composite dropped 145.40 points, or 1.25%, to 11,530.33.
All 11 major S&P sectors closed lower, led by economically sensitive financials which finished down 2.5%. Declining least was the consumer staples index, down 0.97%.
Powell, who will testify again on Wednesday before the House of Representatives Financial Services Committee, also added that the Fed would not consider changing its 2% inflation target and the job market does not suggest an economic downturn is close.
Data influencing the Fed's rate hiking path will include Friday's closely watched nonfarm payroll additions for February. Economists polled by Reuters are expecting an increase of 200,000 jobs compared with the much stronger-than-expected 517,000 jobs reported in January.
While traders were flipping bets in favor of a 50 basis point rate hike this month, Scott Ladner, chief investment officer at Horizon Investments, said the size of the hike would depend on the upcoming payrolls data and inflation numbers.
But John Lynch, chief investment officer for Comerica Wealth Management, argued that with employment and consumption showing strength so far, investors should have been expecting Powell's more hawkish tone.
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 14.5% tumble for Rivian Automotive after the electric automaker unveiled plans to sell bonds worth $1.3 billion.
Dick's Sporting Goods rallied 11% after the retailer forecast annual earnings above Wall Street estimates and more than doubled its quarterly dividend.
Shares of Tesla Inc closed down 3%, failing to get a lift after CEO Elon Musk told an investor conference he saw a clear path to producing a smaller vehicle at half the production cost of the Model 3.
Declining issues outnumbered advancers on the NYSE by a 4.00-to-1 ratio; on Nasdaq, a 2.21-to-1 ratio favored decliners.
The S&P 500 posted 10 new 52-week highs and nine new lows; the Nasdaq Composite recorded 55 new highs and 146 new lows.
On U.S. exchanges 11.17 billion shares changed hands, up from the 10.98 billion average for the last 20 sessions.
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