In a volatile session on currency and equity markets yesterday, sterling fell sharply against the dollar and the euro while the US Nasdaq index shed 200 points as technology stocks faced another sell-off.

Sterling was undermined by a growing belief that UK interest rates were now near their peak. The move provided hope of relief for manufacturers and exporters.

The Bank of England reinforced the belief that rates might not have to rise much higher with its May inflation report, predicting that inflation would be close to the government's target of 2.5 per cent in two years. But Mr Mervyn King, the bank's deputy governor, warned of the danger of inflation posed by a steep drop in sterling, and the possible threat of "turbulence" as it falls to a more sustainable rate against the euro.

Yesterday, against the dollar, sterling fell to a four-year low of $1.51, 8 per cent down from its level at the beginning of the year. The euro rose to more than 60p sterling. Analysts said there was a growing perception in the markets that British interest rates would lag behind the upwards movement in US rates.

"You have had a situation where the US economy has gone from strength to strength while the UK economy has begun to flag, and the exchange rate is moving to reflect that," said Mr Paul Meggyesi of Deutsche Bank.

In the US, concern about future earnings of major technology stocks Intel and Motorola dragged down market sentiment.

Intel was hit by earnings fears after announcing it would undertake to replace defective circuit boards in a move that could cost it hundreds of millions of dollars.

Motorola was hit by a ratings downgrade from Salomon Smith Barney, which sparked a sell-off of the sector.

The twin blows damaged fragile investor confidence in the market, dragging it close to the lows set last month.