Bloomberg obtained a very interesting document which was prepared by European Union (EU) officials prior to the Feb 14 G7 meeting in Rome.

According to the document, the pound’s “very rapid” drop “raises questions about the financial stability of the British economy.” Officials believe the currency’s weakness “is a source of concern for the euro area,” and could worsen the euro zone's recession by undermining exports to its biggest trading partner.

The pound fell by 23% against the euro in 2008, hitting a low of 98 pence in December.

The one-page document, titled “Recent exchange rate developments - G7 preparation,” was circulated at a meeting of EU officials before the G-7 gathering in Rome. The document also outlined the EU’s position on the U.S. dollar, the yuan and the yen before discussing the pound.

The Obama administration’s expression of support for a “strong dollar” is “reassuring,” the document said. It also called for a “continued real effective appreciation” of the yen against the euro and went on to say that Japanese authorities “should not intervene to reverse the past appreciation of the yen,” it says.

Europe’s officials were also concerned that global currency volatility could roil markets and destabilize their economies.

“Exceptionally high volatility and unprecedented sharp moves in the foreign-exchange market have adverse implications for economic and financial stability and are especially unwelcome in the current economic environment,” the draft document said. “In a context of low inflation in all major economies, any large moves will translate into big real exchange rate swings that could lead to competitive distortions.”

France’s Christine Lagarde said Jan. 21 that the Bank of England’s monetary policy “isn’t very efficient in providing more support” for the pound. Ireland’s Brian Lenihan said that Britain is engaging in “competitive devaluation.”

The pound fell about 100 pips against the dollar within minutes after it was announced that Ukraine’s credit rating was cut two levels by Standard & Poor’s. Political turmoil poses growing risks to the country’s International Monetary Fund loan, the rating agency said.

The long-term foreign currency rating was lowered to CCC+, seven levels below investment grade, the rating company said in an e-mailed statement. Ukraine’s rating is now the lowest in Europe and on a par with Pakistan. S&P left Ukraine’s outlook negative, indicating it may reduce the ratings further.

Latvian debt was downgraded to junk on Tuesday because of a “worsening external outlook” triggered by the global financial crisis.

“The downgrades reflect intensifying execution risks associated with Ukraine’s arrangement with the IMF, due to the absence of broad political backing for necessary budgetary revisions and banking system reform ahead of the January 2010 presidential elections,” S&P said in the statement.

Contracts to protect Ukraine’s government bonds against default cost 59.5% upfront and 5% a year, according to CMA Datavision prices for credit-default swaps. That means it costs $5.95 million in advance and $500,000 a year to protect $10 million of bonds for five years. The cost is higher than for any other government debt worldwide.

Eastern Europe’s economies have been hit by financial meltdown and economic recession. Those countries ran large current account deficits and borrowed heavily in foreign currencies, primary the dollar, euro and pound, in the years leading up to the credit crisis. As their sovereign debt is downgraded the currencies weaken, effectively making government debt more expensive to repay.

S&P defines an obligation rated CCC as “currently vulnerable to nonpayment, and is dependent upon favorable business, financial and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.”