Once again the pound is in trouble. This week alone sterling has plunged by more than 10% against the dollar. In July £1 was still worth $2. Last week its value fell to close to $1.50, its weakest level in six years.

Curiously, British officials aren’t showing concern yet. During past sterling crises, the government went to great lengths to stop the pound falling. During the exchange rate mechanism (ERM) debacle of 1992 the chancellor even raised interest rates briefly to 15% despite the fact the country was still recovering from recession.

This time, however, policymakers have actually welcomed sterling’s fall. Mervyn King, governor of the Bank of England, suggested this week the pound may face a larger than expected adjustment as Britain enters recession. This duly pushed sterling down on the currency markets.

So should King and other officials seek a weaker currency? Could the fall in the pound become a rout that complicates policymaking further?

The benefits of a cheaper currency are clear. Before the financial markets seized up last summer and house prices started to fall, consumers were the engine of growth in the economy. This isn’t the case anymore. The government can’t take up the slack. Having already run up large budget deficits during the good times and faced now with the grave challenge of shoring up the country’s banks, the Treasury isn’t able to increase public spending substantially.

Similarly, the rise of inflation to 17-year highs has prevented the Bank, until this month, from cutting interest rates aggressively.

This has left the pound as one of the few tools the authorities have to support the economy. Though news headlines tend to focus on the strength of sterling against the dollar, the level of the pound against the euro is of more importance to the UK economy as 50% of British exports go to the eurozone.

At the onset of the credit crunch last year, the Bank’s monetary policy committee (MPC) was able to cut the cost of borrowing three times in quarter-point steps.

As America’s Federal Reserve was also lowering interest rates, sterling followed the dollar down against the euro. The two Anglo-Saxon currencies fell because investors were now earning less interest from holding assets priced in dollars or pounds.

The lower level of the pound against the euro resulted in British exports becoming more competitive in the eurozone while making imports more expensive. This helped cushion Britain’s overall trade balance and provided a boost to the economy.

However, this month’s plunge of the pound against the dollar comes as sterling remains weak against the euro. As Asian countries target their own currencies against the American dollar, the pound is also losing value against the Japanese yen and Chinese yuan.

Britain’s economy is thus exposed to two big risks. First, consumer prices are already rising at an annual rate of 5%, far above the 2% inflation target. Though inflation is forecast to fall steeply as oil prices plunge and the UK economy declines, a collapse in the pound now would raise the cost of imports and thus adversely affect expectations on inflation.

Second, the British economy still runs a large trade deficit with the rest of the world. This makes it dependent on foreigners buying UK assets to offset the shortfall in its trade position. But if overseas investors shy away from British investments now as the pound plunges, sterling and the FTSE 100 index will become trapped in a vicious downward cycle.

This is the clear risk now. In an orderly world the pound would trade around its long-term fair value of $1.55. Just as sterling overshot sharply on the way up above $2, it now risks undershooting substantially on the way down.

At a minimum, investors should consider the possibility that sterling falls below the lows it recorded at the start of the decade - about $1.38 to the pound. This would match the collapse of the pound after sterling’s ejection from the ERM in 1992. But an even worse crisis in sterling can’t be ruled out now given the trends of the foreign-exchange markets.

Policymakers should be careful about what they wish for with the currency.

- Mansoor Mohi-Uddin is managing director of foreign-exchange strategy at UBS

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