(Recasts, changes byline, updates prices, adds quotes)
By Simon Falush
LONDON, Sept 17 (Reuters) - Sterling fell to its lowest level in a year on a trade weighted basis and the yen strengthened on Monday as problems at Northern Rock bank heightened risk aversion and led investors to pare back carry trades.
The dollar steadied around half a cent away from the previous week's record lows versus the euro, with markets braced for a cut in U.S. interest rates on Tuesday.
However, continuing uncertainty in financial markets caused by problems at UK mortgage lender Northern Rock was the key driver of currencies. It was forced to seek an emergency credit line from the Bank of England, fanning concerns that more financial institutions could be hit by high interbank lending rates.
"Sterling has been trashed on all crosses after further developments in Northern Rock led to increased risk aversion and safe haven currencies to be bid," said Adam Cole, global head of FX currency strategy at RBC Capital Markets.
At 0941 GMT the euro had risen as high as 69.51 pence, its highest level since July 2006 <EURGBP=>. Against a basket of currencies the pound was at 102.1, its lowest level in a year <=GBP>.
The low yielding yen was up 1 percent versus the pound at 229.20 yen <GBPJPY=R> and up 0.4 percent versus the dollar at 114.91 <JPY=>.
The euro edged lower to $1.3861 <EUR=>, but was still within sight of last week's record highs at $1.3927 according to Reuters data.
FED IN FOCUS
The market is convinced the Federal Reserve will cut the fed funds rate by at least 25 basis points from 5.25 percent on Tuesday to help cushion the U.S. economy from the housing market slowdown.
U.S. data on Friday showing an unexpected fall in core retail sales and weaker than forecast industrial output in August further boosted the case for lower U.S. interest rates
"Looking at (market) pricing, it seems to be almost completely even, 50-50, between a 25 basis points cut or a larger cut," said Johan Javeus, FX strategist at SEB in Stockholm.
"I think it's likely that most markets will be in wait-and-see mode right now unless, of course, we see any more disturbing news from the corporate sector -- either from the investment banks delivering results this week, or from other events like what we saw with Northern Rock last week."
Starting with Lehman Brothers on Tuesday, major U.S. investment banks release their latest results this week, perhaps showing just how costly the credit squeeze has been.
Markets are convinced the U.S. Federal Reserve will lower rates and markets are increasingly pricing in a cut from the Bank of England, but the ECB is sounding a more hawkish tone.
Several policymakers from the European Central Bank warned over the weekend that inflation risks in the euro zone were still on the high side, leaving the door open for a tightening once credit markets calmed down.
(To see full report double click on [ID:nL15314274]).
Likewise, the Bank of Japan is still inclined to raise rates in the next few months even if it leaves them unchanged as expected this week.
U.S. Treasury Secretary Henry Paulson said on Monday he expected market turbulence to continue for a while, but noted that the backdrop was still one of global financial strength.