Bank of Canada surprised the currency market by taking its overnight interest rate to a mere 25bp becoming the second lowest yielding currency in the G10 universe matching the rates of US and Switzerland.

The euro sliced through the 1.3000 level while the pound dropped below 1.4600 in early European trade as concern over ECB policy actions and some risk aversion flows in European equities weighed on high beta currencies at the start of the week. Comments over the week-end by ECB chief Jean Claude Trichet suggested that the central bank may lower rates by another 25bp to 1.00 percent while ECB Executive Board member Lorenzo Bini Smaghi said the bank’s benchmark 1.25 percent interest rate is “very close” to its floor.

The EUR/USD broke the key psychological barrier of 1.3000 in early Asian trade this morning after comments over the week-end by ECB chief Jean Claude Trichet suggested that the central bank may lower rates by another 25bp to 1.00 percent while ECB Executive Board member Lorenzo Bini Smaghi said the bank’s benchmark 1.25 percent interest rate is “very close” to its floor. The ECB council continues to be divided over the proper monetary policy path given the economic weakness in the region and this disagreement amongst policymakers has created tremendous uncertainty for the currency as traders deciding to sell first and ask questions later.

Tomorrow the ECB is expected to lower rates by 50bp bringing the overnight rate to 1%. Given the gloomy recent economic data t from the region, the rate cut seems almost pre-ordained. With EZ unemployment rising to a three year high of 8.5% while retail sales in Germany, the union’s largest economy, contracting by another -0.2%, the situation on the ground remains grim. Therefore the markets are pricing in a 100% possibility of a 50bp cut.

As expected ECB cut rates by 50 basis point taking the overnight rate below the 2% barrier for the first time since the euro began. With Eurozone economy contracting by -1.5% in the latest quarter and unemployment skyrocketing across the region, the generally hawkish central bank had no choice but to ease monetary policy further.

On a night when the rest of the G10 currencies consolidated their losses in listless, event free trading, cable was the main source of action dropping 200 points from its highs on news that Bank of England voted unanimously for quantitative easing. The BOE voted 9-0 to expand its monetary policy initiatives beyond rate cutting and 8-1 to lower rates by 50bp with Blachflower once again calling for 100bp cut.

Bank of England dropped the benchmark UK interest rate to 1.5% easing by 50bp as expected. The Monetary Policy Committee noted that the sharp drop in the pound provided additional stimulus to the UK economy tempering the need for more drastic rate cuts at the present time. The Central Bank acknowledged the severity of the UK recession stating that business and consumer confidence have declines markedly while noting that output is likely to drop sharply in the first half of 2009.

Tuesday’s FOMC meeting will be remembered for decades to come as the Federal Reserve brings interest rates down to the lowest level this generation has ever seen. With 2 realistic options on the table and economist and traders divided on how much the Fed will cut interest rates, the only certain outcome is significant volatility for the currency market. No matter how you look at it, an interest rate of 0.50 percent is just as unattractive as an interest rate of 0.25 percent.