LONDON (MarketWatch) -- The euro and the British pound plunged against the U.S. dollar and the Japanese yen Wednesday, pressured by further fund repatriation and expectations the European Central Bank and the Bank of England will move to aggressively cut interest rates in coming months.
"Investors continue to flock to the dollar as speculation mounts that central banks elsewhere will continue with aggressive rate cuts in an attempt to stimulate growth in the near term," said James Hughes, analyst at CMC Markets.
The yen, which has been the ultimate safe-haven currency during recent financial turmoil, posted broad gains.
The euro dropped to its lowest level against the greenback since February 2007, breaking key chart support at $1.3000 and plunging as far as $1.2743.
The euro trimmed losses ahead of midday in European trade to change hands at $1.2912, down from $1.3046 in late North American trade Tuesday.
The euro remained off sharply against the Japanese unit to 127.43 Japanese yen, after trading at its lowest level against the Japanese unit since April 2004 and down from 130.73 yen late Tuesday.
The pound tumbled through important support at $1.7000 on Tuesday and extended losses to its lowest level since September 2003. Sterling recently traded at $1.6382, off from $1.6694 late Tuesday.
The pound is off 3.2% against the Japanese currency to 161.886.
The dollar fell to 98.71 yen from 100.38 yen late Tuesday.
The dollar index , a measure of the greenback against a trade-weighted basket of six major currencies, traded at 85.156, up from 84.434 after trading at its highest level since November 2006.
The sharp downward pressure on the euro comes even as signs point to further stabilization of the financial sector. Instead, the focus has turned to prospects for a deep recession, pressuring the euro even though the United States and the Federal Reserve must also wrestle with a steep downturn, traders said.
"The same old reasoning still applies: The U.S. is regarded as being able to weather a recession much better than the euro zone," wrote strategists at Commerzbank. "And the [European Central Bank] has a much longer way to go in cutting interest rates than the Fed, which was much quicker and has already delivered the bulk of its interest-rate cuts in this cycle."
Strategists at UniCredit MIB in Milan said fund repatriation to the United States and Japan were the primary driving force behind the moves, while sterling saw added pressure from Bank of England Gov. Mervyn King's warning Tuesday night that the British economy had entered a recession.
Minutes released Wednesday from the emergency meeting of Bank of England policy makers on Oct. 8 underlined expectations for further, aggressive cuts, economists said.
The minutes showed the nine-member Monetary Policy Committee unanimously backed the decision to join other major central banks in cutting key interest rates. The central bank slashed the bank rate by a half of a percentage point on Oct. 8 to 4.5%. See full story.
Following the minutes and King's remarks, there is "very little doubt that the easing cycle will be front-loaded and the repo rate will likely be cut to 3%" by the end of the first quarter of 2009, said Chiara Corsa, economist at UniCredit MIB. "We expect the next 50 basis point rate cut in November."
Also, the pound was left particularly vulnerable by the U.K. banking sector's reliance on external capital flows to finance lending, said Naeem Wahid, currency strategist at HBOS.
" These external flows have now fallen sharply [and] unless they are replaced by other forms of external finance the adjustments in the trade deficit and the exchange rate will need to be faster than would otherwise have occurred, implying a rise in domestic saving and weakness in domestic spending in the short-run," Wahid said.
Meanwhile, volatile currency action could attract attention from Group of Seven policy makers, one strategist warned.
"Although we would not argue that the major currency pairs are substantially out of line at present ... an argument can certainly be made that the G7 members would prefer to see a sharp decline in the levels of volatility seen in the currency markets," said Simon Derrick, currency strategist at Bank of New York Mellon, in a research note.
The recent instability in currency markets could further unsettle other asset markets, Derrick said, noting sharp overnight losses in Asian equity markets.
