The US stock market rallied to its highest levels in almost a year, while in Tokyo, shares surged in early trading to their best levels since December.

In the US, optimism about an economic recovery spread through Wall Street. The main indices rose more than 2 per cent, with the benchmark S&P 500 index rising 22.25 to 1,010.86, its first close above 1,000 since June 2002.

Russ Koesterich, US equity strategist at State Street, said: "Real long-term money is coming back into the market and [investors] are buying on dips."

Arthur Hogan, chief market analyst at Jefferies & Co, said: "It's incredible but the S&P is playing catch up with the other indices. People are surprised about the strength of this rally."

The Dow Jones Industrial Average rose 201.84 points to 9,318.96 while the Nasdaq composite continued to lead the market higher, closing up 40.83 points to 1,667.32. The Nasdaq is up 2 5 per cent in the year to date.

Optimism on Wall Street spread to Japan as markets opened on Tuesday. Tokyo's Nikkei stock average powered through 9,000 in morning trade, for the first time since early December.

Stocks were boosted by a report that showed conditions in US manufacturing were improving faster than the market had expected. The Federal Reserve report was in contrast to a consumer confidence survey released on Friday that sent stock prices lower.

Keith Keenan, head of trading at Wall Street Access, said investors were expecting the Federal Reserve to cut short-term interest rates by another 50 basis points, which would reduce the federal funds rate to 0.75 per cent.

"A lot of [investors] believe the Fed will do whatever it can to reignite the economy."

Wall Street's advance kept an early rally in European markets on track. In early evening trade on Monday the FTSE Eurotop 300 index of Europe's largest companies registered a rise of 1.7 per cent at a five-month high of 868.

Akber Khan, at Deutsche Bank, said: "The euro fell against the dollar and the markets went up in a straight line. We are also continuing to see a wall of money coming into the markets. Fund managers who are underweight in various companies are buying ahead of the end of the quarter, macro funds are moving from bonds into equities and other investors are coming to the conclusion that since compani es are buying one another, why not buy the stock?"

Frankfurt, Paris and Amsterdam all gained 2 per cent thanks to a rebound in financial stocks, while blue chip stocks in London made modest gains on Monday. The FTSE 100 index added 0.5 per cent to 4,152.9 although the mid cap FTSE 250 eased 0.1 per cent to 5,035.1. Monday's advance in Frankfurt, took gains for the Xetra Dax index since its mid-March lows to 47 per cent, making it Europe's best-performing market over the period.

Analysts said the biggest test of Wall Street sentiment would be whether the S&P could sustain a trading level above the 1,000 mark. They added that, with the end of the second quarter just two weeks away, portfolio managers will probably continue to rotate money back into equities from the bond market. "The key point is that this is not just a hedge-fund induced fast money rally. Pension funds and other big [institutions] are putting money in. This could be a long-term rally," said Mr Koesterich.