Analysts blamed warnings from the Bank of England on Tuesday that Brexit risks were "crystallising" and fears about the UK commercial property market.
The pound has now fallen by about 14% against the dollar since hitting $1.50 ahead of the referendum result.
"Pessimistic predictions for sterling are coming true," said Andrew Edwards, chief executive of ETX Capital. "The pound is the chief proxy for the post-Brexit mood in the markets."
Against the euro, the pound was down 0.5% at €1.1697 on Wednesday, its lowest level since 2013.
Property sell-off
On the UK stock market, the FTSE 100 index dropped slightly to 6,529.11.
Domestic companies such as supermarkets, housebuilders and banks have fallen sharply, and the FTSE 250 - which contains more UK-focused companies - was down 1% at 15,569.34 in early trade.
Tesco and Morrisons were two of the biggest losers, with their shares dropping 4.9% and 3.4% respectively after analysts warned of a potential price war among supermarkets.
Property-related stocks have been especially hard hit this week after three fund managers decided to stop investors withdrawing money from their UK property funds. Shares in Barratt Developments and Taylor Wimpey fell by a further 4%,
"The suspension of commercial property fund redemptions by a number of big players has precipitated a broader sell-off in the UK property sector including housebuilders and other asset managers," said Michael Hewson of CMC Markets.
`Buyers` remorse`
European stock markets fell more sharply, with the Paris Cac, Frankfurt Dax and Madrid Ibex indexes all dropping by 1%.
Investors are showing some "buyers` remorse" after last week`s stock market rebound and are focusing on "weak spots of the European economy", Mr Hewson said.
Europe`s financial sector, in particular, is under pressure after the European Central Bank warned that Italian lender Banca Monte dei Paschi di Siena, the world`s oldest bank, had dangerously high levels of bad debt.
Earlier, Asian stock markets had closed lower, with Japan`s Nikkei index down 1.9%.
Flight to safety
Government bond yields have also fallen to record lows as investors rush to put money in perceived havens.
Yields on 10-year US and Swiss government bonds hit new record lows, while those of Denmark and the Netherlands dropped to just above zero.
High demand pushes up bond prices, and when the price of bonds rises, their yield falls.
The yield on the 20-year Japanese government bond turned negative for the first time on Wednesday, underlining the hit investors are willing to take to keep their money in rock-solid government debt.
The price of gold also touched a two-year high of $1,371.40 an ounce, as it surpassed the $1,358.20 mark it reached on 24 June in the immediate aftermath of the Brexit vote.
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