Pound plunges against US dollar

The British pound has fallen to its lowest level against the dollar since September 1985, on the expectation of a rapid entry into Europe's Economic and Monetary Union.

During Monday trading the pound plunged 3.4% to $1.3682. At 0700 GMT on Tuesday the pound had recovered only very slightly to $1.3687.

The downward pressure was caused by expectations that the newly elected Labour government will push for an early adoption of the euro.

So far this year, the pound has fallen 8.1% against the dollar.

Although the US is suffering a grinding economic slowdown - and despite a series of interest rate cuts - the dollar has retained its strength against the world's leading currencies this year.

This is because it is regarded as a safe haven for investors, who are more worried about the prospect of global economic turmoil than the reality of a sharp slowdown of the US economy.

Taking weakening action

If the UK government wants to join the eurozone, it is widely believed that it will want to do so at a lower exchange rate, which would make British industry more competitive. To achieve this, the government would have to take action to weaken the pound.

The pound's value against the euro would be fixed in the run-up to joining the eurozone, well before the euro would become legal tender in the UK.

Sterling would no longer exist as an international currency, and the UK would be subject to the fluctuations of the euro on currency markets.

In the past two years, the euro has fallen by 30% against the dollar - but it is now expected to recover some of those losses.

That means that if Britain was to join the eurozone, the UK would need both a lower exchange rate against the dollar and a lower rate against the euro in order to make its export industries competitive.

Nervous times

Market observers say that the pound's exchange rate is likely to be very volatile until a clear policy on the euro is established and a date for a referendum is agreed.

In his first four years in power, Tony Blair has sat on the fence, declaring he was in favour of ditching the pound, but that he would wait until economic conditions were right and the public agreed to the change.

Polls suggest up to 70% of Britons want to keep the pound, but a clear majority also expect to be using euros within 10 years, like it or not.

Some economists have suggested that the pound would have to weaken between 10 and 30% against the euro in order to enter on an equal footing.