Sterling reached a 26-year high against an ailing dollar today while the euro hit an all-time high after rating agency Standard & Poor's warned that it may downgrade $12 billion of debt backed by US sub-prime mortgages.

Standard & Poor’s said that it may cut its ratings on 612 residential mortgage-backed securities, affecting $12 billion in debt, as part of an overall change in its methods for evaluating such debt.

This may force institutions who have pledged to buy only investment-graded debt, to sell their holdings, triggering a wider devaluation of corporate bonds.

Profit warnings from DR Horton, the house builder, and Home Depot, the home improvements firm, added to concerns that trouble in the US subprime market — catering to borrowers with problems in their credit history — could spill over to the wider US economy and led to a sell off of corporate bonds and the dollar.

The dollar had already been under broad pressure due to expectations that the Federal Reserve will keep interest rates on hold for the rest of the year, while other central banks, including the Bank of England, are expected to raise them.

By mid-afternoon, sterling had risen as high as $2.0245 its highest since 1981.

The euro set record peaks against the dollar above $1.37.

Economic data out today, including a narrowing British trade deficit and buoyant retail sales growth, painted a picture of a reasonably robust economy, supporting expectations of higher rates.

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