Sterling hit a record low against the euro and a basket of currencies on Monday, stung by an ongoing view that the weak UK economy will require more interest rate cuts.
The euro climbed to 97.98 pence in extremely thin trade, edging closer to parity after figures showed that UK home prices fell in December, taking them nearly 10 percent lower since the start of the credit crunch in August 2007.
As evidence shows the UK economy is falling deeper into recession, the Bank of England is expected to cut rates more, which would keep British borrowing costs below those in the euro zone and make euro zone investments more appealing than UK ones.
"Sterling is continuing to be hit by the belief that rates in the UK still have to fall much more, and underlying fears of a very deep recession in the UK," said Antje Praefcke, currency strategist at CBCM in Frankfurt.
"There's still a gravitational pull toward parity (with the euro) in the thin market," she added.
The euro has soared more than 32 percent against sterling this year -- jumping a record 18 percent so far this month alone -- and its rise on Monday pushed the UK currency down to 74.2 on a trade-weighted basis, its lowest according to daily records kept by the BoE which date back to 1990.
Sterling suffered across the board, slipping 0.1 percent against the dollar to $1.4630. It tumbled 0.8 percent to 131.72 yen, its weakest level against the Japanese currency since 1995.
Market participants said trading volumes were far lower than usual, which was aggravating year-end trade. In such conditions, many said that it was just a matter of time before the euro reaches parity with sterling.
Many analysts said that the pair may reach parity before the new year due to poor liquidity. Still, they said that the euro may be unable to sustain such lofty gains, given it is already overbought against sterling.
UK ECONOMY SUFFERS
Figures on Monday from property consultant Hometrack showed that housing prices in England and Wales fell 8.7 percent in 2008. They fell 0.9 percent in December, showing that prices have now fallen consistently over the last 15 months and 9.3 percent since the credit crisis began.
Adding to gloom about the UK economy were figures from the Chartered Institute of Personnel and Development at the weekend showing that 600,000 UK jobs could be lost in 2009 due to the recession.
In addition, British children's wear retailer Adams will become the latest UK firm to fall into administration [nLS290132], fuelling speculation that more businesses are poised to fail.
A shrinking UK economy, ongoing deterioration in the housing market and rising unemployment are contributing to an grim outlook in 2009, which has battered sterling across the board.
This has fed the belief that the Bank of England will cut rates further -- and perhaps even explore other options to shore up the economy during in the recession -- even after an aggressive round of cuts has left rates at a five-decade low of 2.0 percent, lower than 2.5 percent in the euro zone.
"There's a sense that UK rates will fall closer to zero, and that the BoE may be forced into some sort of quantitative easing, while there's no sense of that in the euro zone," said Daragh Maher, senior currency strategist at Calyon in London.
He added that the negative view of the UK economy will continue to weigh on the pound, although additional weakness in the euro zone economy may start to chip away at the euro's appeal in the new year.
Higher interest rates in the euro zone have increased the euro's appeal against the pound as it has narrowed the yield spread between euro zone and UK government bonds.
The yield on 10-year UK bonds hovered around 3.121 percent on Monday, near a record low of 3.008 percent hit last week, while the yield on its euro zone counterpart fell to an all-time trough of 2.909 percent.
Both yields have tumbled due to economic deterioration and falling interest rates but the bigger fall in UK yields due to the BoE's particularly aggressive easing has shrunk the yield spread between the two to around 0.109 percent on Monday, the narrowest yield advantage for sterling in a decade.
