London shares rallied tonight and the pound rose against the dollar but investors on Wall Street held their breath ahead of a key decision on interest rates.

The FTSE 100 index was up 263.8 points, or 6.7%, at 4190.2, with insurers, banks and miners leading the charge after weeks of heavy losses. Sterling jumped almost seven cents against the greenback, putting it on course for the biggest two-day rise in more than 23 years.

The pound was up 6.9 cents to $1.628 on speculation the rally on the stock market will bolster demand for the British currency. The Footsie took its lead from strong gains in Asia this morning and a dramatic rally last night in New York, where the Dow Jones Industrial Average surged 11% in its second-best session on record.

It came on hopes a rate cut by the US Federal Reserve tonight would be followed by similar moves in Britain, Europe and Asia in the coming days.

"Sentiment has turned around on hopes of rate cuts around the world," said Mark Outten, a dealer at GFT Global Markets.

But the Dow was down 24.93 at 9040.19 ahead of the Fed decision and analysts warned the rally in the pound and stock markets could be short-lived as the US, Britain and the global economy enter recession.

John Higgins of Capital Economics said: "The bounce in sterling from its recent trough does not mean the UK currency is off the hook. We continue to expect the pound to drop to $1.50 by early next year."

The Footsie is still down more than 2500 points, or almost 40%, on a year ago. Analysts warned the volatility was set to continue as the fallout from the financial crisis continued.

Andrew Turnbull of ODL Securities said: "As ever, we must remain cautious and whilst many of us in the industry would love to treat this as a turning point in the markets, such hopes could be naive considering the bleak outlook for our over-leveraged net-importing economy."

David Buik of BGC Partners said: "Make no mistake, the credit crisis is only just starting and the recession is just about under way. It seems inconceivable that equities will not be subjected to further vagaries and a very uncomfortable ride."