Nothing is more dispiriting than handing over a thick wedge of notes at an airport foreign exchange kiosk and receiving a slimmer-than-expected envelope in return.

As the pound plunged to new lows against the euro yesterday, travellers heading to European destinations were receiving as little as €103 in exchange for £100. Eight years ago they would have received €65 more.

The decline of the pound erodes spending power at an alarming rate. A €3 beer in a Spanish bar would have cost £2.19 last year but now costs £2.71. A €70 ticket to see AC Milan will cost British football fans about 20 per cent more than last year.

Those who have booked ski trips early next year could be even more badly hit as fears rise that the pound’s tumble will continue

Peter Spencer, Professor of Finance at the University of York, said: “It’s hard to tell where the floor will be.”

Investors are acting on Britain’s grim economic outlook and the likelihood of further severe rate cuts. The Bank of England has reduced interest rates by 3 percentage points, to 2 per cent, since October and economists are forecasting that the rate could fall to 0 per cent next year.

Just as savers flock to banks offering the best interest rates, currency investors plump for countries with stable economies and a higher rate of interest. The European Central Bank has an interest rate of 2.5 per cent.

Equally important, the decline also reflects the fact that foreign investors are selling sterling-denominated assets, such as shares of UK-listed companies, to bring their funds home because of worldwide shortages of capital caused by the credit crunch. The fall in demand for sterling to invest in assets in Britain places downward pressure on the pound.

Investors also appear to be taking a view that the eurozone’s prospects, while dragged down by laggards such as Portugal, Italy, Ireland, Greece and Spain – nicknamed the “PIIGS” by some economists – are still brighter than Britain’s.

The UK is seen as particularly vulnerable to a global slowdown because of its overreliance on the financial services sector. The severe slump in house prices has also left the economy exposed to a sharper downturn than its leading international rivals.

Anxieties over Britain’s economic prospects have risen as the Government has been forced to increase public borrowing to fund a bailout of British banks and a tax-and-spending giveaway to underpin economic activity. Worries over the scale of that borrowing have intensified as the national debt looks likely to surge to more than £1 trillion, or 57 per cent of national income (GDP).

The euro may be scaling new heights against the pound, but it was not always this way. When the single currency was introduced in 1999 it was ridiculed as a “toilet currency” by experts who questioned how 12 nations could be shoehorned into the control of a single central bank.

Investors swerved to other, safer currencies such as the dollar and the pound, both of which soared against the new currency. That did not worry holidaymakers, however, who could snap up bargains from Paris to Naples armed with almost €1.75 to the pound.

But as the dot-com bubble burst, sterling’s dominance began to falter. The economy stuttered, and in response the Bank of England initiated a series of ten rate cuts over three years. Sterling fell more than 8 per cent against the euro in the first half of 2003 alone.

The pound regained some ground later in the year as the Bank began to increase interest rates once more, but it never scaled the heights of 2000.

As the credit crisis unfolded last year, sterling was hit by investors’ fears about British banks’ exposure to sub-prime loans. Ironically, the first signs of the damage that this could wreak were in Germany, where two banks had to be rescued. But Britain, with its close alliances with many American banks, was also seen as a sitting duck.

Sterling slid once more as Northern Rock’s problems unfolded, eventually evening out at about €1.27 for several months, buoyed by the Bank of England’s reluctance to cut interest rates amid fears that inflation could rise.

But as the economic news deteriorated sharply, the Bank was forced to cut rates repeatedly. If that process reaches 0 per cent next year, sterling’s decline can only continue.

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