The pound yesterday hit fresh all-time lows against the euro for a second consecutive day, weighed down by the weakness of the UK economy and consequent expectations of further deep cuts in benchmark interest rates.

The latest quarterly inflation report from the Bank of England, published today, is expected to signal further big cuts in UK base rates. The Bank's Monetary Policy Committee astounded financial markets last Thursday by cutting base rates by one-and-a-half points to 3% - the lowest level since 1955.

Great expectations of further big cuts in UK base rates ensured the pound remained on the ropes yesterday. Some economists are predicting rates might fall as low as 1% - the current level of the US Fed funds rate. Benchmark UK interest rates have not fallen below 2% since Bank of England records began in 1694.

The euro rose as high as 82.14p during trading yesterday - its highest level against the pound since its launch in 1999. The euro had, on Monday, breached 82p for the first time and went as high as 82.08p during that session.

Sterling was also weak against the dollar again yesterday.

It was last night trading just below $1.54 - more than two cents lower than its close in London on Monday.

The pound also hit a fresh 12-year low yesterday on its trade-weighted index against a basket of currencies.

John Higgins, economist at London-based consultancy Capital Economics, said: "Relative interest-rate differentials provide one explanation for the latest slide in the pound after the MPC wielded its axe last Thursday. And the relative interest rate outlook is a key reason why we still expect to see a little more weakness against the dollar, with a forecast of $1.50 by early next year."

The European Central Bank last week cut benchmark interest rates in the 15-nation eurozone by a half-point to 3.25%.

Higgins noted that, during the past 15 years, the UK base rate had traded at an average spread of close to two percentage points above the key refinancing rate in the eurozone, taking the German repo rate as a pre-European Monetary Union proxy.

"Not any longer," he declared yesterday.

"In fact, we have to go back to 1994 to find the last time monetary policy was comparatively looser in the UK than in Germany. What's more, rate differentials are unlikely to become positive for the pound any time soon...Not only is the trough in rates likely to be even lower in the UK than across the Channel, but monetary policy should remain extremely loose for several years in both regions."

He added: "Shrinking rate differentials are not just relevant for the pound/euro exchange rate, either. The UK base rate is also likely to fall to 50 (basis points) above Fed funds next year - considerably less than the spread currently discounted in markets."

In spite of this, Higgins believed the "rout" of the pound might be coming to an end.

He said: "The rout for sterling may soon be over. Currency movements are not just influenced by the relative outlook for interest rates. And the better news for the pound is that the decline in its trade-weighted value now almost matches the one-quarter fall experienced by the US dollar between 2002 and early this year.

"It is also broadly comparable to the 18%-or-so drop observed in the wake of sterling's exit from the ERM (European Exchange Rate Mechanism) in 1992. Admittedly, the pound's fall is not currently providing much of a boost to UK exports owing to the rapid deterioration in global demand. But the current account deficit should improve in time."

Howard Archer, chief UK economist at consultancy IHS Global Insight, said today's quarterly inflation report "is likely to give important clues as to just how quickly and how far interest rates are likely to fall following the central bank's slashing of its key rate from 4.5% to 3% last Thursday".

Archer added: "Given the extent of the interest-rate cut and the Bank's very gloomy accompanying statement (last Thursday), it is clear that the central bank is now highly concerned that the UK will suffer a deep, extended recession, and that consumer price inflation could substantially undershoot its 2% target level over the medium-term.

"Consequently, we expect the Bank of England to slash both its GDP (gross domestic product) and inflation forecasts. Critically, we expect the Bank's forecasts to show that consumer price inflation is likely to significantly undershoot its 2% target level on a two-year horizon at current interest-rate levels, thereby leaving the door wide open for further marked reductions in interest rates over the coming months."

He is forecasting the MPC will cut base rates by a further half-point to 2.5% in December and bring them down to 1.5% by mid-2009.

Predicting that the UK economy would contract by 1.5% next year and that benchmark annual UK consumer prices index inflation would have plummeted from its September level of 5.2% to 0.5% by the end of 2009, Archer said: "Furthermore, we would certainly not rule out interest rates falling further still."