The Bank of England has warned of a number of risks to the UK economy next year, in comments that analysts have said point to lower interest rates.
The Bank of England expects economic growth to slow
In its quarterly Inflation Report, the Bank forecast the economy would slow in 2008 and inflation would accelerate.
However, it added that even if interest rates fell by half a percentage point, it would still hit inflation targets.
Analysts said that this signals that interest rates should dip next year from their current level of 5.75%.
The pound fell to a four year-low against the euro as investors bet that UK interest rates would be cut before their European counterparts.
Investors typically look for markets with higher interest rates as they offer better rates of return.
The pound also fell against the US dollar, though analysts pointed out that sterling had previously been trading at its highest levels against the greenback since the start of the 1980s.
"November's Inflation Report gives a clear signal that a series of interest rate cuts lies ahead," said Vicky Redwood, an economist at Capital Economics.
The Bank warned, however, that there was a lot of uncertainty over the outlook for the economy, particularly as the world financial system was still vulnerable to further shocks from factors such as surging energy prices.
It noted there were some signs of a softening in house prices, but said that the link between the housing market and consumer spending was a complex one.
At the same time, it warned that stock markets, which have rallied this year, risked a fall that could hurt the global economy.
"It's very striking that despite developments we've seen in the last three months, equity prices are on average higher now than they were in August," said Mervyn King, the bank's governor.
"There must be some downside risks there. That's factored into our projections. That's the bigger risk to the global economy," King said.
In its report, the Bank forecast that growth was expected to ease as the impact of five rate rises in 15 months, the current strength of the pound and the recent uncertainty in financial markets slows the economy.
The Bank cut its 2008 economic growth forecasts to around 2.2%, following a similar downgrade by the Treasury.
But the Bank also expects inflation to rise in the short-term as higher energy prices begin to bite.
"Today's report appears to point to an easing in monetary policy in the months ahead to accommodate the Bank's weaker projections for gross domestic production growth in 2008," said Neil Mellor at Bank of New York.
"But then somewhat higher inflation for 2008 could well prove a hindrance to the Bank's designs on policy," he added.
The report marks the first formal assessment of the impact of the credit crunch that has gripped markets.