Pound slumps to seven-year low against US dollar

The pound slumped to its lowest level against the US dollar in more than seven years today as fears over the Government's financial bail-out and UK debt gripped markets.

Sterling slumped to below the psychologically significant 1.40 mark against the greenback, hitting a low of 1.39.

The pound also fell against the euro to around 1.07, undoing much of its recent gains against the currency.

Mark O'Sullivan, dealing director at Currencies Direct, said the falls took sterling back to a level last seen in July 2001.

He said they were partly due to investors' reaction to yesterday's second bank bail-out and worries that further measures may be needed.

But he said there were also fears that the UK's debts could be downgraded - meaning UK Government borrowing could become more expensive.

"Is the second bail-out the answer or are the banks going to have to come back again or be nationalised?" he said.

"Second, will the debt be downgraded?"

He said today's slump represented a 3 per cent drop for the pound against the dollar and warned if the Government's plan does not work, sterling could fall by a further 10 per cent.

But he said the UK was not the only country to be facing a debt mountain adding that the US government's state aid packages had created similar worries.

James Hughes, market analyst at CMC Markets, said the falls would have been affected by yesterday's Government bail-out and the announcement by RBS that it estimated bad debts and write-downs on the value of past acquisitions could put it as much as £28 billion in the red.

But he dismissed the idea that the UK was "going to become the next Iceland" and said any talk of bankruptcy was premature.

"They are a factor and a possibility, but they are a long way off," he said.

He said official figures showing the biggest fall in inflation last month since the recession of the early 1990s, was likely to have weighed on markets.

The fall in the annual rate of UK inflation - as measured by the Consumer Prices Index (CPI) - fell to 3.1 per ceny from 4.1 per cent in December, according to the Office for National Statistics (ONS).

Another reason could be the strong performance of the US dollar, based on the "feel good factor" of the inauguration of Barack Obama as president.

The pound has suffered steep falls against the dollar over the past year since hitting a high of 2.04 in March last year.