In movie terms this is Bullitt versus Too Fast, Too Furious. The stars of the latter film, turbocharged rice-burners from Honda, Nissan and Toyota, currently hold the affections of the young, hip street racers of California. To break this Japanese stranglehold on America's youth, Ford needs to generate an emotional reason to buy its products.

Ford is big into resurrecting past glories at the moment - witness the success of the GT supercar - so it has retreated into its back catalogue to create the latest iteration of that American staple, the Mustang. And what better version of the Mustang to draw inspiration from than the 390 GT Fastback immortalised in Peter Yates' 1968 cult classic, Bullitt.

This was the original Mustang, born in 1964 and at its introduction the world's fastest-ever selling car. Since then the 'pony car' has became a cultural icon in the States. An old US Navy recruitment ad ran: 'The Beach Boys. Apple pie. The '67 Mustang. Three things worth fighting for.' Wilson Pickett celebrated the Ford in his song Mustang Sally, and the car came to represent the working man's performance wheels.

In Bullitt Steve McQueen may have looked cool in his Mustang - and its over-dubbed soundtrack was fantastic - but the truth is that throughout the decades the Mustang has been a pretty terrible car. Fast in a straight line, yes, but lacking any steering precision, and unrefined. And Ford's budget road burner has often suffered the look of a fashion victim, with every ghastly automotive trend tacked onto its body.

But in 2001, Ford's chief designer and retro-meister, J Mays (for it was he who designed the new VW Beetle, Ford Thunderbird, new GT40 and the AC Shelby Cobra), became convinced that what America's young folk wanted wasn't 'a glass box on wheels, a sushi disco palace, or Microsoft Windows on the dashboard. What young people want,' he proclaimed, 'is a Mustang.'

The result is what you see here. An amalgam of the 1965 and 1967 Fastback models and the 1969 to 1970 Mach 1 Mustangs, given a sprinkle of clean, modern style and some razzle- dazzle from Ford's chassis tuning genius. The all-new 2005 Mustang will sell in the US for a jaw-dropping $19,410 for the V6 and $24,995 for the V8. Put a ΂£ sign in front and, with the exchange rate, import costs and a chunk of profit, that's about what UK importers will bee asking.

Underpinning the retro looks is a new bodyshell that's 30 per cent stiffer and stronger than the outgoing Mustang's. The front suspension is redesigned with MacPherson struts, a thicker anti-roll bar and a new power-assisted steering system. At the rear, the Mustang is probably the last American vehicle to have a live axle without a pickup bed. Ford has strengthened the axle casing, positioned the springs and dampers directly on the axle tubes and given the whole caboodle a more positive three-link location, including a Panhard rod to limit sideways movement. Ventilated brake discs have been uprated, with stronger callipers and optional anti-lock.

The 4.6-litre, all-aluminium-alloy V8 is from the F-series pickup truck, with drive-by-wire throttles, larger-diameter exhausts and variable camshaft timing for the new single-cam heads to give 300bhp. The iron-block V6 is a derivative of the old Cologne engine from the Granada, giving 210bhp. There's a five-speed automatic option for the first time in a Mustang and a standard five-speed manual with a revised shift. And the optional traction control system has the courtesy to allow you proper muscle-car burn-outs.

Inside, the new Mustang has gone back to its roots, with a smart chrome-edged instrument binnacle, individual instruments and distinctive eye-ball ventilation outlets. The facia is still rudimentary, but it has a refreshing integrity and is much better put together than its predecessor's. The interior is also larger in every dimension, with more comfortable front seats.

Even in V8-happy America, the Mustang's deep-bass exhaust woofle turns heads, and although the engine is slow to react to the throttle, it revs quickly and cleanly. The gear-lever has a small gate and the shift is stiff. First gear is a short ratio, all the better for impromptu drag racing. Underway, however, third pulls from walking pace to 70mph, so you tend to drive the Mustang on its torque rather than whizzing up and down the 'box.

In a straight line the Mustang is like driving into the opening credits of your own road movie, the big V8 bellowing up the rev counter, the transmission rattling and fizzing and the axle moaning and whining. Refinement? It's not bad, but no match for a European or Japanese coupe.

Suspension and steering modifications have transformed the cornering experience, but you need to remember that live rear axle (which Ford claims current Mustang owners demanded it keep). On a bumpy road, the tail is never too far from a slide. At least the direct, well-weighted steering allows you to confidently keep the car on track. There isn't a huge amount of feedback, but you can often exploit the wheels' wildly varying camber angles by steering the car on the throttle. A handful, yes, but unlike previous Mustangs, it's a controllable handful.

The ride has suffered slightly with the revised suspension and the V8's standard 17in Pirellis pick up on the concrete edges of California's interstates with loud reports. In some ways the V6-powered car, with its 16in wheels and BF Goodrich rubber is a more communicative beast. It has less overall grip, but the chassis and the steering give much more feedback. The new brakes are powerful, but as Americans regard brake dust on wheels as a warranty issue, the pads are made of the hardest imaginable material and as a consequence the anchors lack initial bite and fade on long downhill sections.

Whether the Mustang will sell to the young and terminally hip, or to older owners and fans of the epochal Sixties Mustangs remains to be seen. Either way, the Mustang range won't stay still for long. A cabriolet version is due next year and higher performance options like the Cobra Mustang, with fully independent rear suspension, are also expected. Tuning companies such as Roush, Saleen and Kenny Brown are working on performance packs, and body kits will abound at this November's parts and equipment SEMA show in Las Vegas. Ford will not officially bring the Mustang to Britain, but the specialist importers are already taking orders.

Don't walk away with the idea that the new Mustang is some sort of ornery, unrefined beast, best left in America. It ain't so. It's a deftly styled remake of a classic, and visually and dynamically a huge improvement on its predecessor. It's an involving and demanding drive, yes, but it is also a lot of fun and, when all's said and done, isn't that what we want?