Pound sinks against euro amid Bank warnings

The pound sank to levels not seen for five months against the euro today amid Bank of England warnings over the sustainability of the exchange rate.

Sterling dropped as low as 1.101 against the euro today, the lowest level since early April, while it also slipped to 1.6135 against the dollar.

In its quarterly economic bulletin, the Bank mulled the reasons for the pound's sharp depreciation last year and said foreign investors could be less willing to buy UK assets, damaging the pound's long-term prospects.

The Bank said the economic crisis, the UK's current account deficit and the country's reliance on the financial sector have played a part.

It also noted that the exchange rate may have "moved above its long-run sustainable level" in the years leading up to the crisis.

"It is also possible that sterling's depreciation may be part of a more prolonged process of rebalancing of the UK economy, generating a fall in the long-run sustainable real exchange rate, although it is again difficult to obtain direct evidence about this possibility," the report said.

Mark O'Sullivan, dealing director at Currencies Direct, said the pound could be heading back down towards parity with the European single currency.

"The horizon looks to be fairly bleak for the UK," he said.

Mr O'Sullivan said the start of the political season, with pledges across the parties for cuts in spending, had hit confidence in the UK currency.

Rumours over banks being forced to lend - including speculation over negative interest rates, which would penalise institutions for holding cash - had also taken their toll.

He said traders were looking to currencies that provided richer rewards like the Canadian and Australian dollars.

"Sterling is under performing any currency at the moment and it is difficult to see this side of the end of the year how it is going to stage a fight back," he said.

"It feels like it is set for fairly large moves lower because it is difficult to find any reason to buy sterling at the moment."

He added that while the currency was already falling, the Bank's report was having an effect.

The Bank's report said the UK had consistently run current account deficits averaging around 2% of economic output since the mid-1990s as UK businesses, households and government borrowed from abroad to fund consumption and investment.

"Provided the foreign investors were content to build up claims on the future earnings of UK residents in the form of financial assets, such an imbalance of domestic expenditure over savings was sustainable," the Bank said.

"But the financial crisis may have led overseas investors to reassess their willingness or ability to purchase sterling assets and thereby finance the UK trade deficit."

The bank added that the "potentially more pronounced effect" of the crisis on the UK financial sector compared with other countries "could be perceived to have led to a permanent fall in UK households' and firms' income".

It said this could be one of the reasons why investors "might perceive that the financial crisis had prompted a fundamental shift in demand away from UK goods and services".

The report added that the Bank's unprecedented £175 billion quantitative easing policy - essentially printing money to buy assets and boost the money supply - could have had an effect.

Sterling would tend to depreciate if the policy caused investors to "rebalance" portfolios away from UK assets, it noted, but countered that the pound would rise if the scheme was seen as boosting the economic prospects for the country.