FOREX-Dollar climb knocks pound to 7-1/2-yr low, euro weaker

By Naomi Tajitsu

LONDON, Jan 21 (Reuters) - Sterling tumbled on Wednesday, hitting a 7-1/2-year low against the dollar, as intensified risk aversion drove investors back into the U.S. currency which reached its strongest levels against the euro in six weeks.

The pound extended deep losses on the view that an ailing UK financial sector will keep the economy weak despite bank bailouts, fiscal stimulus and drastic interest rate cuts. A surge in UK joblessness also kept sterling weak.

Economic worries around the world stung global stock markets and sliding European shares kept pressure high to dump risky assets, boosting the dollar and the yen.

"There's a lot of jitters in the financial markets, and it's taking its toll on currencies which have stressed capital financing needs and which are particularly exposed to financial sector weakness," said Phyllis Papadavid, currency strategist at Societe Generale in London.

She added that this had put sterling in the firing line, and that the euro would also continue to suffer.

Sterling was hit as UK banking shares took a beating on the view that the British financial sector continues to deteriorate despite the government's latest bank rescue plan, putting the broader economy in deep trouble.

Bank of England Governor Mervyn King said on Tuesday that the UK economy will likely shrink significantly in the first half of the year, and that policymakers need to consider using more than just interest rates to stimulate demand. [ID:nLK713961]

Economic worries were not confined to the UK, however. European shares .FTEU3 fell 1.7 percent and edged towards their lowest in nearly six years, reminding investors that the global economy is continuing to suffer despite dramatic rate cuts and fiscal stimulus plans by authorities around the world.

Sterling fell more than 1 percent to $1.3715, its weakest since mid-2001. The pair has fallen more than 7 percent so far this week, its biggest weekly slide since late October.

Sterling dropped across the board, hitting a record low of 123.01 yen against the low-yielding Japanese yen, which tends to rally during periods of risk aversion.

The euro rose more than 1 percent to 94.10 pence, its strongest since the start of the month and inched closer to a record high around 98 pence hit last month.

Despite the euro's gains against sterling, the single currency fell to $1.2845 on electronic trading platform EBS, its lowest level since Dec. 9.

This boosted the dollar across the board, pushing the U.S. currency .DXY as high as 86.504 against a basket of currencies, its highest level since early December.

Against the yen, the dollar was little changed at 89.90 yen.

"It's still a positive environment for the dollar, with equities down. The dollar and the yen are still strong in this risk-averse environment," said Marcus Hettinger, global currency strategist at Credit Suisse in Zurich.

"With other central banks cutting rates down to the level of the U.S. and Japanese central banks, there's still more downside for currencies like sterling and the euro."

UK DATA, BOE MINUTES

Keeping sterling out of favour were figures on Wednesday showing that the UK claimant count jumped by 77,900, the 11th straight month of rises, while a broad measure of unemployment rose to 6.1 percent from 6.0 percent, its highest since the three months to April 1999. [ID:nONS004013]

Minutes from the BoE's monetary policy meeting earlier this month showed that one member voted to cut rates by 100 basis points, before the central bank ultimately decided to cut by 50 basis points to 1.5 percent. [ID:nLL446707]

The UK currency's latest pummelling was sparked after the Royal Bank of Scotland announced massive losses on Monday, which reinforced investor worries about the UK's hobbling financial sector.

The euro has been hurt lately by sovereign debt rating downgrades to euro zone member nations including Spain, and deteriorating economic prospects, which analysts say could hasten monetary easing by the European Central Bank.

Speaking before a committee of the European Parliament, ECB President Jean-Claude Trichet on Wednesday played down the threat of deflation, while rebuffing rumours that some euro zone member would leave the union given the financial crisis. [ID:nLL367087]

He added that all global currencies were under pressure.

(Editing by Stephen Nisbet)