Sterling and the dollar are declining in value as they lose some of their "safe haven" currency status, allowing the pound to climb slightly against them. As calm returns to the stock markets both currencies have lost ground as investors put money back into the Wall Street and London equity markets.

As a result the pound closed at 85.98p against sterling from 85.60p a day earlier, while sterling fell to 2.9210 deutschmarks from DM2.9320.

According to Mr Kevin Daly, economist at Ulster Bank, an article by Mr Anatole Kaletsky in The Times of London also contributed to the selling pressure on sterling.

Mr Kaletsky argued that the stock market turmoil was the start of a bear market rather than a simple correction.

He warned that both the dollar and sterling could crash alongside world equity markets as consumers and companies in both markets are most reliant on equity savings and financing. These are also the two economies most dependent on financial services.

And the danger could be particularly great for sterling. The European Central Bank (ECB) would do its utmost to prevent the euro from rising too sharply against the dollar - if necessary by cutting rates more aggressively than the US Fed.

But sterling would not be underpinned in this way as the ECB would be indifferent to its plight.

Furthermore, according to Mr Jim Power, chief economist at Bank of Ireland, a large-scale repatriation of funds from Japanese companies following bank restructuring and end-of-September book balancing is also boosting the yen and putting pressure on the dollar.

The dollar is also suffering on foot of investor fears that the contagion may spread to Latin America, Mr Power noted.

Other factors also weighing on the dollar and sterling include the expectation that rates may fall, according to Mr Power.

Many analysts are now expecting UK rates to be cut by as much as half a percentage point by the end of the year as the economy there slows. And sterling is likely to begin to fall even before the rate cut appears, according to Mr Power.

As a result the pound will be trading at round 90p before the year is out, he added.

In contrast, the deutschmark drew support from the reaffirmation yesterday by the German Finance Minister, Mr Theo Waigel, that German economic growth for 1998 could be expected "around 3 per cent". However, late yesterday the German economics research institute DIW called for the Bundesbank to cut German interest rates soon in order to ward off the danger of deflation.

"Up until now there has been no sign that the Bundesbank would react to very clear deflationary trends by cutting rates. But by holding on, the German central bank is only increasing the danger of deflation," the DIW said.

The institute said that recent price developments only underlined the danger. Consumer price inflation in western Germany slowed to 0.7 per cent in August, the lowest rate in more than 11 years. And if the rate is adjusted for the increase in value-added tax in April, consumer prices stagnated, the DIW said.

The Bundesbank is scheduled to hold its regular fortnightly central council meeting today, but few expect a cut in interest rates to be announced.