European markets rally in response to gains in US

Markets rallied across Europe yesterday in delayed reaction to Monday's gains in the US, with the performance boosted in the afternoon by unexpectedly positive data on US inflation.

In Dublin, shares ended almost 2 per cent higher, while London's FTSE closed nearly 1 per cent stronger, reaching levels last seen nine months ago.

New five-month highs were the order of the day in Paris, Frankfurt and Milan. The main catalyst for the gains came from fresh US inflation numbers, which appeared to rule out any immediate threat of deflation in the struggling US economy.

The indicator showed a slight increase in inflation for the first time in nine months.

Economic commentators were reluctant to take too much hope from the one-month rise however, predicting that the rally of recent days could lose some steam if the Federal Reserve limits itself to a 0.25 per cent reduction in interest rates when it meets next week.

Ulster Bank financial markets economist, Mr Niall Dunne, described current stock movements as "reactionary and directionless". "Traders have been betting on 50 points and have been moving out of deposits because of that. It's not a very solid basis for a rally," he said.

Mr Dunne is expecting further volatility over coming days in both stock and currency markets.

The correlation between currencies and the stock markets has largely broken down of late, thus adding to the instability of the overall picture.

The dollar also displayed a degree of fickleness yesterday, regaining a cent against the euro before falling back to $1.1813 in late European trade.

Mr Dunne said the dollar could be pushed into a new rally if the Federal Reserve chooses 25 over 50 points next week, thus ensuring that the yield differential between the US and the euro zone does not widen as much as many had feared.

He remains convinced of the euro's upside potential over the dollar in the medium term however.

Sterling also registered an advance against the euro yesterday, as Mr Stephen Nickell, a member of the UK's monetary policy committee, moved away from suggestions that an interest cut could be on the way.

The UK currency was trading at just above 70p against the euro last night, a level which Mr Dunne said may be attractive for those looking to hedge sterling exposure.

Mr Jim Power, chief economist with Friends First, agreed yesterday that the market optimism of recent weeks has been overdone, as the US economy remains fundamentally fragile. He is expecting the current rally to pause or fall back before the end of summer, and is even more cautious about the euro-zone picture.

Yesterday saw another member of the governing council of the European Central Bank state that the current level of interest rates in the euro zone was appropriate to promote economic recovery.

Austrian central banker, Mr Klaus Liebscher said the prevailing conditions for financing did not represent a barrier for "investments or other growth impulses".