"The Bank of England is on the brink of doing a U-turn on rates," said Neil MacKinnon, a director at Burke and MacKinnon, an independent hedge fund advisory firm. Mr MacKinnon said he expects the bank will cut rates this week and could even shave two percentage points off rates next year.
The prospect of lower rates drove the pound to a 16-month low against the deutschmark at 2.7777 marks. It was little changed against the dollar at 1.7053.
While lower rates usually stimulate economic growth, they often weaken a currency by lowering money-market returns. The Bank of England left interest rates untouched at 7.5 per cent at its last meeting, though evidence of a lapse in domestic growth and a cut in US rates could force rates lower as early as this week.
A report on Thursday showed that UK manufacturing slipped for a sixth straight month. The Chartered Institute of Purchasing and Supply's manufacturing index rose to 46.4 in September from a revised 45.3 in August. A reading below 50 indicates the manufacturing sector is contracting.
"A combination of a rapidly deteriorating international background and increasing evidence of a marked deterioration in business conditions in the UK since the summer should tip the balance in favour of a 25 basis- point cut" at this week's meeting of the Monetary Policy Committee, said James Barty, economist at Deutsche Bank. The MPC meets on Wednesday and Thursday, with an announcement expected at midday on Thursday.
In New York, the dollar tumbled to a 20-month low against the mark and fell versus other major currencies on expectations that US interest rates will fall before the end of the year and amid pessimism about US stocks.
The dollar also fell against the yen as legislators in Japan, after months of bickering, approved a plan to clean up the nation's bad-debt-laden banking system, a step seen as critical to lifting the economy out of recession.
"The markets are seeing further cuts in interest rates in the US and a weakening of financial institutions here," said Guillermo Estebanez, senior economist at Bank of America in San Francisco. "The combination of these things cannot be positive for the dollar."
The dollar fell to 1.6390 marks on Friday, having dropped as low as 1.6283 marks, its weakest since 24 January 1997. The dollar dropped to 135.20 yen from 135.88. For the week, the dollar fell 2.4 per cent versus the mark and 1 per cent against the yen.
The Dow Jones index has fallen 14 per cent in the last two months. Falling US stocks hurt the dollar because international investors selling equities often convert the dollar proceeds to other currencies. Given the turbulence in global markets, many foreign investors are withdrawing to the safety of their domestic bond markets, sending bond yields to record lows.
Concerns about slower growth in Latin America is also undermining the dollar because the US does 18 per cent of its trade with the region. "Add the problems in South America, where Brazil is touch and go, and you have an extra problem for the dollar," said Mr Estebanez.Reuse content