Is a war already priced into the market?

Shares in Europe and Asia had jumped following President Bush's speech on Monday night, giving Saddam Hussein a 48-hour ultimatum to leave Iraq or face military action.

After a tentative start on Wall Street, US stocks rose in early trade. But they later fell back to hover within a few points of the previous day's close, along with some European markets.

Mr Bush's speech was seen as removing the last vestige of uncertainty and gave traders room to hope for a short, sharp war that would not cause lasting economic damage.

But still worries about the post-war scenario - and about whether oil flows will be disrupted - took the edge off the rally of the past few sessions.

Oil price drops

The blue-chip Dow Jones industrial average was up 52 points, or 0.64%, to 8,194. The broader Standard and Poor's 500 index rose 3.66 points, or 0.42%, to 866.45.

This is distracting the markets temporarily Jean-Pascal Rolandez, BNP Paribas Click here to find out why shares have been rising

Stock markets in France, Germany and the UK had all risen strongly during morning trade, before sentiment cooled in the afternoon.

By 1745 GMT, London's FTSE 100 index had closed 25 points or 0.67% higher at 3,747.3 points, while Frankfurt's Dax - which stays open till about 1900 GMT - was trading 1.5% higher at 2,525.

But the Cac-40 index in Paris ended the session lower, falling back 1.3% to 2,794.89.

Earlier, Tokyo's leading stock index, the Nikkei, had closed 83 points or 1% higher at 7,954.

The commodity markets, meanwhile, reflected the hope of a swift end to the Iraqi crisis: safe havens such as gold and government bonds fell while oil prices dropped.

In London, the benchmark Brent crude oil fell by more than $2 to a three-month low of $27.30 a barrel.

And the dollar, which had been weakening ahead of the crisis, clawed back a small amount of its recent losses against both the euro and the yen.

Distraction

There had been some concern that the recent upswing in the stock markets could not be sustained and that the rally was not rational.

A rate cut is on many people's minds

In 1991, a rapid victory over Iraq triggered a strong rally.

But analysts point out that the markets were then in the middle of a bull run, unlike the current bear market.

"This is distracting the market temporarily from fundamentals," said Jean-Pascal Rolandez, a strategist at BNP Paribas.

"Provided it's over quickly, people will have to go back to worldwide fundamentals which are deteriorating."

Storing ammunition

An interest rate decision by the US Federal Reserve will also weigh on traders minds on Tuesday.

The bank's chairman, Alan Greenspan, will make the announcement at 1915 GMT.

But few traders were expecting action until the economic impact of the possible war with Iraq became clearer.

US interest rates are already at a 41-year low of 1.25%.

"If the war goes badly, the Fed is going to need all the ammunition it has," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.