The pound continued to make a small recovery against the dollar this morning, as the reaction to the Federal Reserve's interest rate cut continued to be absorbed by markets around the world.

Earlier this week, sterling plunged to almost a six-year low against the dollar but it climbed yesterday in anticipation of the Fed's move to cut interest rates to 1 per cent. It continued its recovery today, hitting $1.6637 in early trading in London compared with $1.6411 at yesterday afternoon's close.

However, by 4.30pm it had fallen to $1.6296 and remains significantly lower than the $2.01 level it reached just three months ago.

London's stock market had a relatively subdued opening in comparison with Asian markets, despite the Fed's aggressive action of cutting its official interest rate by another half point.

The British market closed up 1.16 per cent to close at 4,291.65 points.

Mining shares and commodities were boosted by the weaker dollar and financial companies were among the biggest risers. However, oil company shares had a mixed performance with Royal Dutch Shell falling 1.1 per cent, despite beating all forecasts with third-quarter current cost of supply net profit up 71 per cent at $10.9 billion.

Among other companies reporting results, consumer goods giant Unilever ended down 0.52 per cent after it posted a rise in third-quarter underlying sales and upgraded its 2008 outlook to sales growth “well in excess” of its target of 3 to 5 per cent.

Europe's small rally was in sharp contrast to the reaction in Asia, where markets bounced in response to the overnight interest rate cut by the US Federal Reserve and the “bold” economic stimulus measures in Japan.

The Nikkei’s 10 per cent jump, rising 817.8 points, followed yet more softening of the yen, bringing relief to exporters such as Canon, Toshiba and Fujitsu with large exposure to foreign exchange movements.

The surge meant that, by the closing bell, the Nikkei was back above the critical 9,000 point mark — the “breakeven” level at which the huge stock portfolios of the Japanese banks are no longer generating losses.

Despite the broadly positive moves, bond traders at Royal Bank of Scotland in Tokyo said that there were numerous signs that the financial system remains in chaos.

Just as central banks everywhere are pouring cash into markets, the Bank of Japan drained some Y1.5 trillion (£9 billion) of liquidity from the Tokyo money market as rate-cut expectations sent short-term rates below the bank’s official target.

In Tokyo, hedge funds were badly caught on the wrong side of the yen-related stock surge, forcing many to exit their short positions in a hurry, which in turn amplified the market gains.

The short squeeze, which one Mitsubishi UFJ broker said was “biting like a pitbull”, particularly affected Japanese exporters, but was felt across almost all sectors.

Taro Aso, the Japanese Prime Minister, unveiled a new stimulus package, including Y5 trillion in fresh spending, redoubling its efforts to keep the global financial crisis from aggravating the country's economic slump.

The package is the second Japan has put together this year. The first, presented in late August, was designed to counter high global prices for oil and other resources.

Hong Kong shares soared higher to complete a three-day rally that has advanced the Hang Seng index by some 27 per cent.

In South Korea, trading floors shrugged off persistent doubts over the fundamental health of the economy and banking system and pushed shares more than13 per cent higher.

Fund managers in Hong Kong ascribed the day’s buying spree to a “build-up of belief” that a market rebound was around the corner.

Nevertheless, analysts pointed out that dark clouds remained on the horizon.

The slight weakening of the US dollar prompted a rise in commodities, and an accompanying jump for shares of resource stocks across China and elsewhere.

More worrying, said some, was the news that Volvo received only 155 new orders in Europe for trucks in the most recent quarter — a 99.6 per cent slowdown from the previous year. Signs like that, said commodities brokers in Singapore, explain the huge drop in shipping rates and the “unavoidable” evidence of a global economic slowdown.

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