Wall Street opened sharply higher as US traders, who were on holiday on Monday, digested weekend comments by Alan Greenspan, the Federal Reserve chairman, hinting that rates could fall if the domestic economy slowed. The Dow Jones Industrial Average closed up 380.53 points, or 4.98 per cent, at 8,020.78 - its biggest-ever one-day points gain.
The London market saw some profit-taking after Monday's 180-point rise, which traders said had anticipated yesterday's soaring Dow. The FTSE 100 closed down 2.8 points at 5,344.2, although it had climbed more than 50 points earlier.
Sterling continued to lose ground against the Deutschmark, closing down 1.5 pfennigs at DM2.864, a 12-month low, despite the release of better- than-expected UK economic data.
Elsewhere in Europe, stock markets continued to rally. French stocks ended up 2.93 per cent, while in Frankfurt, the Xetra DAX closed with a gain of 3.03 per cent. In Japan the Nikkei closed up 123.43 at 14,913.49.
Despite the gains, experts remained cautious about the longer-term outlook for stocks. James Cornish, European strategist at BT Alex.Brown said: "Nobody really believes that we're at the end of this correction."
In the UK, the Office for National Statistics said industrial production grew by 0.4 per cent in July and was stable on the year, a better-than- expected result. Manufacturing output - the chief component of industrial production - was up 0.1 per cent on the month and down 0.6 per cent on the year.
Following a raft of gloomy business surveys, the market had been forecasting that manufacturing output would fall by 0.2 per cent in July.
Sterling strengthened on release of the data before falling again in later trading. Economists said the figures could harden the Bank's resolve to keep rates on hold this week. Market turmoil has prompted speculation about a rate cut, although experts say such a move is unlikely this week. Richard Iley at ABN Amro said: "These data, combined with sterling's recent weakness, should underpin unchanged rates this week."
The Bank's Monetary Policy Committee begins its two-day rate setting meeting today. An announcement will be made at midday on Thursday.
Economists pointed out that the reassuring manufacturing data did not necessarily mean the sector was out of the woods. Jonathan Loynes at HSBC Securities said: "This is likely to prove a false dawn. Conditions in industry are set to get worse."
The fragility of much of the UK economy was underlined by two new surveys. The latest BDO Stoy Hayward "poll of polls" found that British business believes the country is "on the brink of recession". The Society of Business Economists said that one in five business economists expected a recession next year.
NIESR, the research institute, said GDP rose by 0.5 per cent in the quarter to July, and forecast that growth in the three months to August would also be 0.5 per cent. NIESR said: "These data suggest that the economy is now growing at or slightly below trend and do not indicate that a recession has started."
Leading article, Review, page 3