Sterling hit a two-and-a-half year low against the dollar and a 16-month trough against the euro on Monday after ratings agency Moody's stripped the UK of one of its prized triple-A ratings, rounding off a week of woe for the currency.

More falls were likely in the near term given a grim outlook for the British economy, the prospect of more monetary easing and growing evidence that the Bank of England (BoE) is comfortable with a falling currency as it seeks to rebalance the economy and encourage more exports.

Markets had been expecting a cut by one of the major ratings agencies for some time, and there had been hopes that the move when it finally arrived could halt a slide in bond and currency markets.

But sterling lost another 0.1 percent to $1.5145 and this year is now down nearly 7 percent against the dollar. It is also down 7.5 percent against the euro.

Its trade-weighted index hit a 17-month low of 78.5.

An earlier low of $1.5073 was its weakest since mid-July 2010, and traders said any bounce towards $1.5250-$1.5300 would be sold into as more speculators and investors took a dim view and built bets against the currency.

The euro was up 1 percent at 87.42 pence, not far from a 16-month high of 87.75 pence. Investors who bought UK gilts as a way of seeking safety from the euro zone crisis last year continued to turn around those bets; gilt futures fell sharply in morning trade.

"(The rating cut) reinforces the perilous economic position the UK is in. It supports the unwinding of the safe haven trade too," said Kathleen Brooks, research director at Forex.com.

"This downgrade may fuel more speculation that QE will be re-started later this year. This is pound-negative for the medium term and we could see sub-$1.50 in the near term."

More quantitative easing is seen as hurting the currency as it involves the central bank printing more money to buy bonds. That increases the supply of the currency and puts more pressure on its value.

GRIM PROSPECTS

Sterling was already under pressure last week after Bank of England minutes showed policymakers, including Governor Mervyn King, have edged closer to another round of easing. The bank's quarterly report earlier this month also said policymakers were prepared to tolerate higher inflation to support growth.

Analysts said the Moody's rating downgrade brought into focus the widening growth differentials between the United States and the UK and pointed to further weakness for the pound, especially against the dollar.

Economists surveyed by Reuters expect the U.S. to grow 1.9 percent in 2013 while Britain is forecast to grow at a much slower pace of 0.9 percent this year.

"One can expect further sterling weakness in the short term, the only question is the extent," said Peter Kinsella, currency strategist at Commerzbank. "US-UK growth differentials indicate sterling/dollar should now trade towards the mid to high-$1.40's and we can expect this to manifest in the coming weeks."

Analysts said by tolerating higher inflation in the coming years, the real or inflation-adjusted returns for investors would diminish, making the pound even less attractive.

"Rising inflation and pound weakness will pare living standards back down," Morgan Stanley strategists said in a morning note. "We expect sterling to fall further and Friday's rating downgrade was a marginal event in dictating the future path of the currency." – Reuters