Sterling hit a 14-month low against the euro and fell versus the dollar on Friday, hit by news that a major UK mortgage lender had become a casualty of the credit squeeze sparked by the US subprime woes.
Worries about the health of the UK housing market were further exacerbated by data from property website Rightmove - released ahead of schedule - showing that house prices fell 2.6 percent in the past month.
The UK government said on Friday it had authorised the Bank of England to provide an unspecified amount of financial support to Northern Rock, which was the country's biggest mortgage lender in the first half of 2007. The company has fallen victim to the credit squeeze, which was sparked by a crisis in the US subprime mortgage market.
Its predicament raises concerns about the impact of the credit crunch on the UK economy as a whole and further cements expectations that British interest rates have likely peaked.
"I think we see Northern Rock as a fairly isolated case ... But nonetheless markets are clearly sensitive to anything that involves the housing market and mortgage lending and raises downside risks to UK rates - as that combination of those two news items (Northern Rock and Rightmove) today clearly have done," said Adam Cole, global head of FX currency strategy at RBC Capital Markets.
By 1403 GMT sterling was down half a percent at $2.0122, around one-week lows. On a trade-weighted basis, the pound fell to a six-month low of 102.9.
The euro added half a percent to 69.01 pence, hitting levels last seen in July 2006 and on track for its biggest weekly gain in percentage terms in nearly two years.
The euro has been supported across the board by expectations that the European Central Bank - unlike its counterparts in other countries - may continue raising interest rates once calm returns to financial markets.
Further clues on the likely path of UK rates will come next week from the release of August inflation data and minutes from this month's Bank of England meeting.
The Northern Rock news comes as there are signs of stabilisation in the credit market - the London interbank offered rates for three-month sterling deposits fixed on Friday at a one-week low of 6.82375 percent, off nine-year peaks above 6.9 percent set earlier this week.
The credit squeeze was caused as banks, uncertain which of them would be caught up in the US subprime mortgage market crisis, became unwilling to lend money to each other for everyday financial operations.