Sterling fell against the dollar and euro on investors' growing sense that the UK economy is facing severe headwinds and that the government is unable do much to support it.
"It calls into question the credibility of fiscal policy at a time when monetary policy looks to be unsustainable," said Adam Cole, global head of FX strategy at RBC Capital Markets, referring to interest rates which, at 5 percent, are crimping growth.
BANK OF ENGLAND DILEMMA
The difficulties facing monetary policy setters were further highlighted on Friday, with Bank of England Deputy Governor John Gieve saying the Bank needed to balance the prospects of slowing growth and increasing unemployment with rising inflation.
He also said he could not rule out a recession.
"The MPC will continue to assess the balance between the risks of higher inflation from the commodity cost shock and the downside risks to output (and to inflation in the medium term from the credit crunch," Gieve said.
While inflation hit 3.8 percent last month, nearly double the Bank's two percent target, the real economy is slowing fast.
Latest evidence of that came from the troubled housing market - Gross mortgage lending fell 3 percent in June to an estimated 23.8 billion pounds, a 32 percent decline from June 2007, the Council of Mortgage Lenders said on Friday.
Construction companies are already suffering. Kier Group said on Friday it would axe around 350 staff, or 60 percent of its workers in its residential division. More than 4,000 job cuts have been announced by homebuilders this month.
A Treasury spokesman earlier said it had always said it would look at the fiscal rules again when the economic cycle ends. But it is not clear when the Treasury will rewrite its rules since dating economic cycles is not an exact science.
Officials are waiting for the Office for National Statistics to produce its "Blue book" revisions at the end of September to get a better idea of when the current cycle might end. There has been speculation it may have ended in the second half of 2006.
While that clearly increases the pressure on the government to adjust the rules to increase borrowing, the ONS revisions could also increase the level of GDP significantly and thus give it extra margin without changing the fiscal rules.
