The uncertainty that undermined markets last week was reinforced over the weekend by reports that Federal Reserve Board members were still divided over the need to raise short-term rates in order to dampen rapid economic expansion. Alan Greenspan, the Fed chairman, and Alan Blinder, vice-chairman, were both said to believe the evidence of overheating was not yet conclusive.
A stream of unexpectedly strong figures during the past few weeks have convinced markets that US growth is still above its sustainable, non- inflationary rate. Most economists predict figures on national output for the third quarter, to be published on Friday, will show the economy growing at an annual rate of more than 3 per cent.
Susan Hering, an economist at the US investment bank Salomon Brothers, said: 'Policy- makers must now convince the markets of their willingness to err on the side of restraint.'
Yet analysts were divided over whether the Fed would act before the next scheduled meeting of its policy committee, the Federal Open Markets Committee, on 15 November. Robert Thomas, an economist at NatWest Markets, said: 'The Fed would have to have a pretty strong case to act just before the congressional elections. They would prefer to delay.'
However, Mark Cliffe, international economist at Midland Global Markets, said: 'Until last week some people thought the Fed could hold off, but the balance of evidence on inflation has swung enough to put the pressure back on.'
The dollar achieved a new post-war low of 96.55 yen on Wednesday before recovering slightly thanks to profit-taking at the end of the week. It closed at Y97.10 and DM1.50 on Friday. Dealers said the market was likely to test whether central banks would intervene to help the US currency, following comments by the US Treasury Secretary, Lloyd Bentsen, late on Friday, saying there would be intervention when it was appropriate.
Long-term US bond prices dipped enough last week to take their yield above the psychological barrier of 8 per cent, although they too rallied slightly at the end of the week.
The uncertainty is likely to affect markets outside the US. Wall Street's 19-point drop last week contributed to a 74-point decline in the FT-SE 100 index, and European bond markets tracked US prices.
Mr Cliffe said: 'If the dollar is the focus of attention, European markets might be able to weather the turmoil, but that has not been the experience so far this year.'