The British pound fell below $2 for the first time this month on Monday as thousands of depositors pulled money from U.K. lender Northern Rock. At the same time, the dollar was slightly weaker against most other currencies ahead of an expected U.S. interest rate cut.
Ongoing uncertainty in financial markets caused by funding problems at Northern Rock, Britain's fifth-biggest mortgage lender, fanned concerns that other financial institutions could be hit by high interbank lending rates.
Northern Rock said on Monday it had not yet drawn any funds from an emergency facility it had arranged with the Bank of England.
"Sterling is being hit by its own problems and there is some support for currencies like the Swiss franc and the yen," said Meg Browne, senior currency strategist at Brown Brothers Harriman. "Big picture, we are rangebound before the Fed," she added.
The dollar steadied around half a cent away from the previous week's record lows against the euro, with markets braced for the Federal Reserve to cut interest rates at its policy meeting on Tuesday.
In late afternoon trading in New York, sterling edged 0.6 percent lower to 1.9943 euros. The euro had risen as high as 69.51 pence, its highest level since July 2006.
Sterling fell 0.6 percent against the low-yielding yen to 229.69 yen.
The dollar fell 0.1 percent to 115.16 yen. Low-yielding currencies got a boost as investors pared back trades seen as more risky.
The euro was little changed against the dollar at $1.3863, but still within sight of last week's record high at $1.3927, according to Reuters data.
The market is convinced the Federal Reserve will cut the benchmark fed funds rate by at least 25 basis points from 5.25 percent on Tuesday to help cushion the U.S. economy from the housing market slowdown.
Recent data including an unexpected fall in core retail sales, weaker-than-forecast industrial output and a drop in U.S. payrolls have boosted the case for lower U.S. interest rates.
"Looking at [futures market] pricing, it seems to be almost completely even, 50-50, between a 25 basis points cut or a larger cut," said Johan Javeus, FX strategist at SEB in Stockholm.
Starting with Lehman Brothers on Tuesday, major U.S. investment banks will report their latest quarterly results this week, which may reveal just how costly the credit squeeze has been.
Markets are also looking at the potential for a rate cut from the Bank of England, though the ECB sounds more hawkish.
Several policy-makers from the European Central Bank warned over the weekend that inflation risks in the euro zone were still on the high side, leaving the door open for a tightening once credit markets calm down.