LONDON - STERLING sank to a record low versus the euro and oil hit a 20-month trough while government bonds rose after a Bank of England report pointing to a sharp economic contraction raised concerns about the global economy.

Two-year US Treasury yields fell to their lowest level since July 2003 while the low-yielding yen rose broadly as investors shied away from riskier currencies.

European shares ticked higher while Wall Street was set for a firmer open after steep losses earlier in the week.

In its quarterly inflation report, which contained its gloomiest set of forecasts in more than a decade, the BoE said the domestic economy had probably already entered recession and was likely to contract further through next year.

The BoE also said inflation could fall to just below 1 per cent in two years, well below its 2 per cent target, suggesting further interest rate cuts to come.

The bank surprised markets last week by cutting an unprecedented 1.5 point off the benchmark cost of borrowing.

'This confirms ... that interest rates are going to go lower,' said Mr Neil Mellor, currency strategist at Bank of New York Mellon.

'We're into unknown territory in terms of modern economies. I think the fear is the possibility of a liquidity-trap style situation.'

Sterling fell as low as 82.37 pence per euro and lost more than one percent to a six-year low of $1.5204. On a trade-weighted basis, it hit 12-year lows.

MSCI world equity index fell 0.15 per cent while FTSEurofirst 300 index rose 0.7 per cent. US stock futures were up around 0.7 per cent.

European banks were one of the underperforming sectors, falling half a per cent.

'Until the banks are able to break free from the government's influence and are able to resume paying dividends to ordinary shareholders, the banks are not particularly attractive investments,' said Mr Tim Gibbens, global financials analyst at UK investment management firm Alliance Trust.

'While tomorrow's banks will be more stable, transparent institutions, the potential upside for shareholders will be capped by lower returns because of lower risk businesses being supported by larger capital bases.'

Emerging stocks fell 1.65 per cent, driven by a more than 10 per cent slide in Russian stocks.

US crude oil lost 1.5 per cent to $58.40 a barrel, falling more than $80 from record peaks hit in July.

The December bund futures rose 7 ticks while two-year US Treasury yields fell to 1.2052 percent, their lowest since July 2003. -- THOMSON REUTERS