A sharp late rally on Wall Street will support European markets this morning, with the Dow Jones index of US shares adding over 100 points in a surprise recovery yesterday evening.

Earlier European markets had rallied after sharp early losses caused by the fall in US shares on Friday.

In volatile trading, European shares closed well down but were off their worst levels of the day. European markets were buoyed by a steady opening in the Dow Jones in New York, which followed its 3.1 per cent fall last Friday, the sharpest fall in the index since the crash in October 1987. The Dow opened slightly stronger, rising 29.50 points (or 0.38 per cent) to 7,724.16 30 minutes after the opening bell.

The US market then briefly moved into negative territory, before a strong rally in the final hour of trading with the Dow Jones index closing 108.7 points higher at 7,803.36, a gain of almost 1.5 per cent, following Friday's 3 per cent decline.

In Europe, where markets fell sharply at the opening, traders remained on tenterhooks during early trading, waiting to see how the US market would open. The steadier opening on Wall Street helped European markets trim early losses.

Friday's fall on Wall Street spurred heavy selling on Asian markets, the first markets to open after the weekend. These markets were also undermined by currency turmoil in the region. In Tokyo, the 225-share Nikkei average fell 1.47 per cent. Germany was one of the worst hit of the European markets falling almost 4 per cent before a late rally. By the close the index was 1.79 per cent lower.

Paris, one of a number of markets closed on Friday for Assumption Day, was particularly hard hit with the CAC-40 down more than 3 per cent at one stage before staging a mini-revival to close 1.77 per cent lower.

In Dublin, the ISEQ index ended the day 1.13 per cent lower at 3614.64. with the bank stocks being the major losers. However, dealers said that trading volumes were low.

Italian, Spanish and Austrian stocks all lost more than 2.5 per cent at the opening.

In London, institutional bargain hunters moved in after an early fall and helped to apply the brakes, restricting the market drop to 30.8 points and a close of 4835.0. Dealers said there was no sign of panic selling and the current correction was seen as a healthy development.

The falls in Europe had been forecast on the basis that European markets would post losses to catch up with the heavy fall in New York on Friday which took place after European bourses had closed.

With Friday's share slide in the US largely attributed to fears of an increase in German interest rates, which could have a knock-on effect of raising rates in other economies, markets are now focused on key meetings this week of the US and German central banks.

The US bond market was quiet in advance of today's meeting by the policy-setting Open Market Committee of the Federal Reserve Board, which analysts forecast will leave interest rates untouched.

On currency markets the dollar fell against the deutschmark as currency markets fretted over the possibility of higher German interest rates. The Bundesbank holds its first meeting on Thursday after the summer break and is to set repurchase rates for bonds today.

Sterling gained almost three pfennigs against a weaker German currency, closing around DM2.9350 while the pound moved up in tandem closing three pfennigs stronger at DM2.6725, and stable against sterling at 91.10p.

The dollar managed to hold just above DM1.81 but this was some eight pfennigs below a near eight-year peak of DM1.8913, hit early this month.

"Sentiment is still fragile ahead of today's German repo tender and the Bundesbank council meeting on Thursday," said Mr Mark Geddes, treasury economist at ABN AMRO.

Some economists doubted whether the German central bank would move towards higher rates at the tender or tighten credit after the council meeting.