Fears that a slowing US economy would see investors divert money into Europe saw the Nasdaq index shed more than 7 per cent and the dollar fall. The Nasdaq suffered its seventh consecutive loss, falling to levels not seen since March 1999, while the blue-chip Dow Jones Industrials lost 2.5 per cent.

The euro was the main beneficiary of the flight of capital from US markets following the US Federal Reserve's declaration that it sees the possibility of a sharp slowdown and an interest rate cut early in the new year.

Analysts said European investors were big buyers of the currency.

US sentiment was also hit by news that president elect Mr George W. Bush will appoint Mr Paul O'Neill as Treasury Secretary.

Analysts expressed concerns that the 65-year-old retiring chief executive of Alcoa lacked market experience.

The euro rose to $0.9056 from $0.8902 yesterday, reaching its highest level since August 18th when it hit $0.9081. It is now above the key technical 200-day moving average for the first time since October 1999 and should remain above $0.90 according to Mr Jim Power, investment director at Friends First.

For the first time in two years, the Fed said yesterday that further weakness was a bigger threat than inflation to the US economy, signalling cuts in interest rates.

The dollar's decline was also fuelled by the fall in US stocks after the Fed's announcement which came on top of downgrades of technology stocks Cisco and Hewlett Packard.

The Fed warnings also affected European shares.

"The market is clearly now focusing on the fact there is going to be a significant reduction in capital spending across the United States," said Mr Jeff Currington, head of European equities at Morley Fund Management.

Investors had believed the impact of a slowing US economy would be restricted to the personal computer market, but are now beginning to assume it will force most companies to cut spending.

Announcing Mr O'Neill's appointment, Mr Bush said: "He has strong credentials in government and in business. He worked at the Office of Management and Budget and had a distinguished record. He's also had vast experience in the private sector. I look forward to having this good man by my side." Mr O'Neill helped direct White House budget policy during the administration of President Gerald Ford in the 1970s. During that time he worked with vice president-elect Mr Dick Cheney, who was then White House chief-of-staff, and Federal Reserve chairman Mr Alan Greenspan, who was Mr Ford's chief economic adviser.

Analysts were divided over Mr O'Neill's nomination with some saying it marked a shift from market based to managerial skills. Others took the view that his contacts and insider-knowledge of Washington would be a bonus.