The pound fell to a 13-year low against a basket of currencies on Friday and hovered close to record lows against the euro as markets braced for further aggressive cuts in UK interest rates in the coming months.
The pound looked set for a record weekly fall against the euro after this week's Bank of England inflation report forecast a sharp decline in prices, suggesting that the central bank will cut rates again after a big 150 basis point reduction last week.
Speaking in New York on Friday, UK Prime Minister Gordon Brown added weight to rate cut expectations by saying that the BoE has scope to cut interest rates in order to bolster the UK's ailing economy.
"All the data and news out of the UK has been on the negative side, suggesting we will see further aggressive rate cuts from the Bank of England, which has kept sterling under pressure," said BNP Paribas senior foreign exchange strategist Ian Stannard. At 1511 GMT, the euro dipped 0.1 percent against the pound to 86.00 pence, but hovered close to a record high hit on Thursday of 86.62 pence.
The UK currency was down nearly 6 percent on the week against the euro, heading towards its worst weekly performance since the single currency was launched in 1999. Against a basket of currencies, sterling hit a 13-year low of 80.5, while it fell 0.8 percent against the dollar to $1.4746, not far off a 6-1/2-year low of $1.4555 hit on Thursday.
The pound's rapid descent also boosted implied volatility, with those on one-month sterling/dollar options rising as high as 29.40 percent. Late last month, it rose to 29.65 percent, the highest level on Reuters data going back to 1995.
"The falls in sterling against the euro have exceeded even our bearish expectations, but it still looks like it has scope to fall further towards 87.00/87.50 pence," BNP Paribas' Stannard said. Rate cut expectations have been backed up by a raft of recent very weak UK data, which have intensified fears of a prolonged and painful recession in the country.
UK retail group John Lewis - seen as a barometer of British retail spending - on Friday reported a 9.7 percent fall in sales at its department stores last week. BTM-UFJ currency economist Lee Hardman said that in previous recessions the UK still retained its relatively high-yield status against other major countries. Now, however, at 3 percent UK interest rates are lower than those in the eurozone and are set to fall further, raising concerns over whether the UK will be able to attract external funding.
"The UK has a deteriorating current account and fiscal deficit and the funding of those deficits will become more and more problematic," he said. Interest rate swap markets as shown by SONIA contracts show that the BoE may cut interest rates by as much as 100 basis points at its next meeting in December.
Next week, UK inflation data is expected to show a sharp fall in prices while Wednesday's minutes to the latest Bank of England will be eyed for hints on how much further borrowing costs will fall.