Evidence of a weak US housing market initially boosted hopes yesterday that the Federal Reserve will decide growth is weak enough to warrant a cut in interest rates.
But equities fell sharply in the last hour of trading, after a retreat in the bond market fuelled concerns that interest rates would not move down in the near future. The Dow Jones closed down 43 points at 5506.21.
A sharp fall in house sales last month - along with better than expected December trade figures - offset separate figures showing the biggest increase in consumer prices in more than two years to send the dollar and Wall Street initially higher.
The Dow Jones climbed to 5593 in morning trading, in the wake of three successive declines. That helped shares in London and the pound rise too, although the gilts market was little changed in view of the mixed success of a pounds 3bn gilts auction.
The FT-SE 100 index closed over 22 points higher at 3738.2, before Wall Street began falling.
In Japan, however, it was a different picture: the Nikkei index ended below 20,000 for the first time since 29 December. Fears that Japanese interest rates might have to rise from their historic low hit the stock market, which closed before the announcement that industrial output rose a modest 0.5 per cent in January.
Several batches of very mixed signals on the American economy during the past two weeks have sent world financial markets on a roller-coaster. Yesterday's statistics were no exception.
A rise of 0.4 per cent in consumer prices last month was driven by higher energy, food, clothing and transportation prices.
A 1.9 per cent jump in energy costs due to bitter weather was the biggest since October 1993. ''Core'' prices, excluding food and energy, climbed 0.3 per cent.
Analysts were, however, less concerned about the small rise in the annual rate of inflation to 2.7 per cent from 2.6 per cent, than by an unexpected drop in home sales.
The number of homes sold fell 4.1 per cent in the month to a 3.71m annual rate. This followed a 3.2 per cent decline in December, suggesting that lower mortgage rates have not stimulated the housing market as anticipated.
The dollar reacted to the good news in yesterday's trade figures. America's trade deficit widened slightly in December, taking the shortfall for the year to just over $111bn, the highest since 1988. US trade with China was a record $33.8bn in the red last year.
On the other hand, America's sensitive bilateral deficit with Japan fell to $3.5bn in December from $4.1bn, and for 1995 as a whole fell from $65.7bn to $59bn - the first decline in four years.
The dollar rose nearly a pfennig to climb above DM1.46.and was steady at around 104.5. The dollar's move helped the pound to rise more than half a pfennig to close at DM2.2425.
Gilts were ruffled by yesterday's pounds 3bn auction. The auction was a success judged by the amount demanded, amounting to 1.48 times the stock on offer.
However, the gap between the average and lowest prices offered was 5 basis points, which disappointed some analysts.