Sterling tumbled 6.7 percent versus the dollar through February, touching the weakest level in almost three years, yet remains 2.3 percent overvalued, based on an Organization for Economic Cooperation and Development measure of purchasing power parity. Options traders have raised bets to the most in almost two years that it will depreciate against the euro, and strategists are cutting their forecasts at the fastest pace after the yen.

The slide reflects growing speculation the Bank of England will boost stimulus while also debasing the currency as the U.K. risks an unprecedented triple-dip recession. Current Governor Mervyn King, who gives way to Bank of Canada Governor Mark Carney in July, has said a weaker pound would help rebalance the economy.

“You ain’t seen nothing yet,” said Neil Williams, chief economist in London at Hermes Fund Managers Ltd., which oversees about $42 billion. “If the world believes there will be significantly more stimulus coming, which I expect, the pound is likely to be under further pressure.”

Sterling Tumbles

The U.K. currency slid to $1.4986 on March 1, the lowest level since July 2010, and down from this year’s high of $1.6381 on Jan. 2. It was at $1.5113 at 5 p.m. New York time Monday, a 7 percent drop from the start of the year, the largest decline after the yen’s 7.3 percent fall.

Sterling tumbled to 88.15 pence per euro on Feb. 25, the weakest level since October 2011, before trading at 86.17 pence per euro. It has depreciated versus the 17-nation currency for seven straight months.

A report last week showed U.K. manufacturing unexpectedly shrank in February, while an index of construction output released yesterday fell to the lowest in more than three years. Britain’s gross domestic product declined 0.3 percent in the last quarter of 2012, according to data published on Feb. 27.

“It is hard to envisage a scenario where we would want to be long sterling in the next six to 12 months,” Thomas Kressin, head of European foreign-exchange at Pimco in Munich, said in a telephone interview on Feb. 25. A long position is a bet an asset will rise in value. “There will be more tolerance for a weaker pound as a way to support growth.”

Purchase Estimates

Pimco, which holds a smaller percentage of pounds than the amount in the benchmark it uses to measure performance, expects the Bank of England will likely to resume asset purchases after already buying 375 billion pounds ($566.6 billion) of debt, according to Kressin.

Sterling has dropped 5.2 percent in 2013, according to Bloomberg Correlation-Weighted Indexes that track 10 developed- nation currencies, trailing only the yen’s 5.5 percent decline. The dollar has gained 2.8 percent.

King and two of his Monetary Policy Committee colleagues voted to expand so-called quantitative easing at the central bank’s Feb. 7 meeting, though they were outvoted by the six other members, according to minutes released Feb. 20.

The central bank will keep its asset-purchase target unchanged at 375 billion pounds when it announces its next decision on March 7, according to 28 of 39 economists surveyed by Bloomberg. Nine forecast an increase of 25 billion pounds, with the remaining two predicting expansion of 50 billion pounds and 75 billion pounds.

Fiscal Constraint

Moody’s Investors Service cut Britain’s credit rating to Aa1 from Aaa on Feb. 22, citing continuing weakness in the economy. The nation’s bonds rallied even with the downgrade.

“The downgrade is likely to reinforce the emphasis on economic stimulus through monetary easing because of the fiscal constraint the U.K. is facing,” Kressin said. “Despite the decline, sterling is not actually cheap or undervalued if you take into account its economic fundamentals. Competitiveness that comes from a weaker currency is offset by high inflation and rising unit labor costs.”

The OECD’s purchasing power parity metrics show that sterling was 9.6 percent overvalued at the end of 2012, and 7.2 percent too strong a year ago.

The three-month 25-delta risk-reversal rate for the euro against the pound showed a 0.42 percentage point premium for euro calls over puts on Feb. 25, the most since May 2011, signaling the pound may weaken further. As recently as Jan. 17, they were indicating sterling would gain. Calls give an investor the right to buy a currency, while puts grant the opposite.

Haven Attributes

The pound’s slide against the euro was tempered last week as inconclusive elections in Italy reignited speculation the region’s debt crisis will worsen, sending traders to assets in nations considered havens.

The U.K. currency strengthened more than 20 percent versus the euro from October 2009, when financial turmoil erupted in Greece, to July 2012, when European Central Bank President Mario Draghi said policy makers would do “whatever it takes” to safeguard the monetary union.

“The development in Europe in recent days favors a return of demand for the pound,” said Robert Rennie, the chief currency strategist at Sydney-based Westpac Banking Corp., the top forecaster in a Bloomberg News survey last quarter.

Westpac estimates the U.K. currency will strengthen to 84 pence per euro by the end of June and has advised customers to sell the euro against the pound, he said.

Net Shorts

Hedge funds and other large speculators last month abandoned bets the pound would strengthen, according to data from the Washington-based Commodity Futures Trading Commission.

The difference in the number of wagers on a decline in sterling compared with those on a gain — so-called net shorts — was 36,130 on Feb. 26, the most in almost a year, compared with net longs of 1,174 as recently as Feb. 5.

Even though the pound has declined by about 20 percent on a trade-weighted basis since King become Bank of England governor in July 2003, International Monetary Fund data show the U.K. still had a current-account deficit of 1.7 percent of GDP last year. Germany had a surplus of 5.2 percent.

“Sterling has dropped a lot but the trade balance hasn’t improved,” John Taylor, founder and chief executive officer at FX Concepts in New York, said in a Feb. 28 telephone interview. “Nothing has improved in the U.K. Its quantitative easing is relatively larger than the U.S.’s given the size of the U.K. economy, but it is not working.”

Forecasts Lowered

Bets that the pound will decline are among the company’s largest so-called short positions, Taylor said.

“If you look at the comparison of historical moves of the pound, this is nothing yet,” Taylor said. “There is more room to go down.”

Analysts have lowered their year-end forecasts for the pound against the euro by 4.8 percent this year to 83 pence, according to the median estimate of analysts surveyed by Bloomberg. That’s the biggest reduction after the decrease in projections for the yen versus the dollar and the 17-nation shared currency.

While the Bank of England’s King denies targeting sterling, he and his colleagues have highlighted the benefits of a drop in the pound. King’s appointed successor Carney has meanwhile said central banks aren’t “maxed out.”

Taylor at FX Concepts said the pound may fall as low as $1.25 in the “longer term” if a weakening economy spurs the central bank to resume stimulus.

“The Bank of England is saying they want sterling to go down,” Taylor said. “Hey, give me a ticket and I’ll take it, thank you. It’s a free flight.”