MIXED signals on the US economy have kept financial markets on edge about the implications for interest rate policy.

Inflation at the factory gate was lower than expected in the US last month, confirming the absence of inflationary pressures. But retail sales did not fall as much as feared during the January blizzards and consumer confidence bounced.

Investors opted to stick to their recent gloom about the scope for further interest rate reductions. US shares fell in morning trading and later the automatic restriction on trading when a fall of more than 50 points was recorded came into effect. The Dow Jones index closed down 15.89 at 5,549.21. Treasury bond prices were also slightly lower.

The drop in US share prices followed a dramatic fall of nearly 500 points - or 2.5 per cent - in Japan's Nikkei index, to a four-month low a fraction above the 20,000 level. Analysts in Tokyo blamed fears that the dollar's recent weakness would hit Japanese exporters again as the dollar briefly fell below 104.

Shares in London and some continental European markets recovered slightly after Monday's declines and a weak opening yesterday, however. The FTSE 100 index ended nearly 12 points higher at 3715.9. However, in Dublin, share prices drifted slightly lower, with the ISEQ index fell 5.73 to 2313.95. Irish Government bond prices firmed slightly at the short end, with the yield on the benchmark five-year stock falling to 6.94 per cent from 7 per cent the previous day.

Mr Elias Bikhazi, an economist at Deutsche Morgan Grenfell in New York, was cautious about US interest rate prospects after yesterday's figures. "We are seeing numbers suggesting that the economy is stabilising. We will avoid a recession, so the Fed can ease a bit more but not aggressively," he said.

Mr Chris Iggo at Chase Manhattan was more pessimistic about the economy, but said: "The figures are so distorted by the weather and the Federal Government shutdown that the fact the economy is weak has not filtered through to the markets."

The clearest evidence for the weak economy view yesterday was the unexpectedly low increase in prices charged at the factory gate last month. They were up only 0.3 per cent, keeping their year-on-year rate of increase at 2.3 per cent.

But signs of growth were stronger than expected. Retail sales fell by 0.3 per cent in January, mainly due to lower car sales, but this was not as big a fall as anticipated.