The euro soared to a seven-week high against the dollar yesterday as a meeting of the governing council of the European Central Bank (ECB) in Frankfurt left interest rates unchanged at 3 per cent.

Amid fears that Wall Street may be heading towards a severe correction and growing expectations that US interest rates are about to rise, the euro leapt to $1.0402, its highest level since November 18th.

The ECB president, Mr Wim Duisenberg, welcomed the increase in the euro's value and admitted that the Bank had expected the new currency to fare better on foreign exchange markets during its first year.

"We were not surprised in the least that the exchange rate of the euro fell during the first few weeks. But I was somewhat surprised that the exchange rate went further and came close to so-called parity with the dollar. I am very pleased it has come back up in recent weeks," he said.

Analysts believe that some of yesterday's gains were due to investors retrieving funds they had invested in the dollar as a safe haven in the event of Y2K problems. Now that the millennium bug has been shown to be a chimera, these funds are now being traded back into other currencies.

"I think the euro can gain more, to $1.05 or above, as there are more Y2K trades to be unwound and nervousness about the Federal Reserve's decision in February will cap stocks," said one analyst.

Mr Duisenberg delivered an upbeat message about the prospects for the euro zone and its currency in 2000 and played down the significance of an expected increase in inflation during the first few months of the year. In remarks that were clearly directed towards German unions negotiating their annual pay round, he said that inflation would soon fall again and that wage claims should be moderate.

Although the euro's rally yesterday owed much to external factors, such as nervousness on Wall Street and the backwash of Y2K, many analysts believe that the currency may finally be recuperating.

"There are a number of signs the euro may have turned the corner and, given how much oneway traffic there has been, this is a potentially significant point for the currency. But what it needs to do is hold the bulk of its gains even if US stocks stabilise. The US equity market was a good determinant of euro/dollar in the past year, and if the euro can hold up when the Dow is not falling three per cent a day, people will be more inclined to believe the trend has changed," said Mr Francis Breedon, currency strategist at Lehman Brothers.