LONDON Sterling hit a two-month low versus the dollar on Wednesday after the Bank of England said Britain faced years of meagre economic growth and left the door open for yet more stimulus.
Comments from BoE governor Mervyn King, who said it would be hard for the economy to grow fast without further falls in the exchange rate, also weighed on the UK currency.
King said the economy may shrink again at the end of this year, just one quarter after it exited recession, and warned that monetary policy could only go so far in helping numb the economic pain.
The pound was last trading at $1.5850, not far from $1.5841, its lowest level since September 5, and down 0.1 percent on the day. Trade-weighted sterling fell to a three-week low of 83.5, according to BoE data.
"King saying the door is not closed on further quantitative easing has not done sterling any favours. The possibility further QE is still out there is what has affected the pound," said Lee McDarby, head of dealing for corporate and institutional treasury at Investec.
Quantitative easing acts as a drag on the currency as it increases its supply.
Strategists said King's comments on the need for a weaker UK currency also weighed on sterling. Trade-weighted sterling has gained 3.2 percent since the start of the year, a factor that has made UK exports less competitive at a time when the BoE is attempting to rebalance the economy towards exports.
"We see King has once again talked about UK competitiveness being hurt by sterling strength. Sterling is under pressure following that," said Ian Stannard, European head of currency strategy at Morgan Stanley.
Stannard remained bearish about sterling's prospects and said its drop below the 200-day moving average could open the door to a fall towards $1.5775, which marked the upper end of sterling's mid-May to mid-August range.
Higher-than-expected inflation data on Tuesday had prompted some investors to scale back bets on more easing, but many analysts said the BoE was more concerned with supporting growth than curbing price pressures.
The minutes from the latest Federal Open Market Committee meeting which are due later on Wednesday and are likely to confirm an easy policy bias for some time could limit the dollar's recent gains and support sterling against it.
UK retail sales figures for October due on Thursday could also push the pound lower if it comes way below expectations.
"Retail sales always have the chance to knock the pound a bit. If the figures are weaker than forecast it could really weigh on the pound and cable and euro-sterling move down lower," McDarby said.
EURO ZONE RISKS
The euro extended gains after it hit a two-week high versus sterling after the BoE's Quarterly Inflation Report to last trade at 80.40 pence.
The gains helped it move away from the November low of 79.60 pence hit last week. Technical strategists expected strong support around that level, with the 100-day moving average coming in at 79.63 pence.
Analysts said moves in sterling would also be driven by broader market appetite to take on risk, with the pound likely to gain against the euro but struggle against the safe-haven dollar if sentiment worsens.
Uncertainty over when international lenders may agree to release the next tranche of aid for Greece, and the risk the U.S. fiscal cliff will push its economy into a renewed recession has also weighed on risk sentiment this week.
"We still see some weakness against the dollar in terms of weaker sentiment. Worries over the euro zone and the U.S. fiscal cliff will support the dollar," said Melinda Burgess, currency strategist at RBS.
(Additional reporting by Nia Williams; Editing by Catherine Evans)