The euro has rallied again on the back of fears that the US downturn could be more precipitous than many had feared.

Economic sentiment in Philadelphia, a key industrial region, has dipped to a new low prompting fears that the next set of US-wide data could show a dramatic downturn. Analysts said the US central bank, the Federal Reserve, may have had an idea of these figures when it cut interest rates earlier this month. They are now assuming the Fed will cut rates by another half percentage point at its meeting on January 31st.

The euro rallied on the news that the manufacturing sector in Philadelphia, the third-largest region in the US, contracted to its weakest position in more than a decade. Its business activity index tumbled to -36.8 in January from -4.2 in December.

The ongoing California power crisis, where bankruptcy of the two biggest providers could come within weeks, also weighed on the dollar, Mr Aziz MacMahon, chief economist at Ulster Bank, pointed out. California is facing more rolling blackouts as emergency measures are put in place for the state to buy power.

There was also bad news on the corporate front as Ford, the world's second-largest car maker, yesterday reported a 33 per cent drop in fourth-quarter operating earnings due to weaker results from its core North American car business. Caterpillar, the world's biggest maker of earth-moving equipment, also forecast declining earnings this year. It reported a fourth-quarter profit that exceeded Wall Street's estimates, but warned that its earnings were likely to decline by 5 to 10 per cent in 2001, causing a 9 per cent drop in stock value. The retail giant, Sears Roebuck, reported a 14 per cent decrease in fourth-quarter operating earnings, as weak holiday sales hurt its retail and credit businesses.

In contrast, economic prospects in Europe remain brighter and the European Central Bank once again left interest rates unchanged at 4.75 per cent following its meeting in Frankfurt. It is not expected to begin cutting rates for at least two to three months.

The ECB's latest monthly report warned that the risk of inflation remained real despite the strengthening of the euro on foreign exchange markets and a recent fall in the price of oil. Mr Tommaso Padoa-Schioppa, a member of the ECB's governing council, confirmed this week that the Bank believed Europe was heading for a boom similar to that enjoyed in the US in recent years.

"The ECB needs inflation to follow a downward trend for two or three months to be able to justify a cut in interest rates," according to Mr Stefan Schneider, an analyst at Deutsche Bank Research.

Uncertainty about the future of oil prices following a decision by OPEC states on Wednesday to cut output may have strengthened the case for holding interest rates steady.

Few private sector analysts share the ECB's optimism about the euro zone's economic prospects. As signs grow that the US downturn could be sharper than expected, the mood in Europe is getting gloomier. Most economic indicators suggest euro zone growth has already peaked and many banks and economic institutions have revised downwards their prediction for growth in 2001.

A growing number of ECB watchers predict the next move on interest rates will be downwards, not least because there are signs that, for the first time since the euro was introduced, the growth in money supply is expected to move below the ECB's target of 4.5 per cent.