Six interest rate increases in the UK since May, and less demand from Asia and emerging markets, will probably convince the Bank of England to lower its benchmark rate from 7.50 per cent this year or early next year. That would mean a lower money-market return on sterling.
"High rates are weakening the UK economy," said Denis Gould, who helps to oversee about pounds 40bn at Axa Sun Life Investment Management. "Rates are going to come down, but they aren't going to come down fast. That will gradually weaken sterling" to 2.75 German marks in 12 to 18 months.
On Friday, the pound was at 2.9037 marks, little changed from 2.9009 late on Thursday in London. It fell to $1.6745, from $1.6771.
The Bank of England's monetary policy committee meets on Wednesday and Thursday for its monthly rate-setting session. All 20 economists in a Bloomberg News poll expect the committee to keep the benchmark rate unchanged.
Eleven of the 20 said they expect a quarter-point rate cut in the first quarter of next year, and three forecast a cut before the end of this year, as the UK economy slows. Lower rates tend to undermine a currency by reducing the money-market return on deposits.
"We've got a sharp and deepening economic slowdown," said Nick Parsons, a currency strategist at Paribas Capital Markets. He expects the pound to fall as low as $1.64 and 2.88 marks this week. "The UK sends a higher proportion of its exports to Asia, compared with continental Europe, and we're suffering from a withdrawal of foreign investment."
Economic reports this week could provide further evidence that the economy is slowing. Economists polled by Bloomberg News expect manufacturing production to have fallen by 0.2 per cent in July from June, giving a decline of 1.1 per cent over 12 months. That report is due on Tuesday.
On Thursday, the Confederation of British Industry will publish its monthly trade survey, which will probably give further evidence that the pound's 24 per cent advance over the past two years is hurting UK manufacturers by making their goods more expensive overseas and competing imports less expensive.
The dollar was little changed against the yen on Friday, as US stocks failed to stage a convincing rebound and amid waning prospects that the Federal Reserve will lower interest rates to calm global markets.
"The fact that stocks can't sustain a rally and Latin America concerns persist make me concerned about the dollar," said John Rothfield, an international economist at NationsBanc in Chicago. "We don't think the current environment is a time to be buying dollars." He sees the currency falling as low as 130 yen and 1.70 marks next week.
Last week, the dollar fell 5.3 per cent against the yen and 1.5 per cent against the mark. Much of that decline was driven by speculation that the Fed would cut rates.
The US currency began to give up gains after the Labor Department said that the US economy had added a robust 365,000 jobs last month, as expected, giving the Federal Reserve less reason to cut rates.