By Harry Robertson

LONDON (Reuters) -Sterling dropped sharply on Wednesday after the Bank of England said it would step in to calm the UK government bond market, a sign of the turbulence that has rocked British assets since the government’s fiscal policy announcement late last week.

The pound was down 0.65% to $1.0666, after hitting a session low of $1.0539. It was on track for its biggest monthly fall against the dollar since the financial crisis in autumn 2008, having shed almost 9% in October alone.

The euro was up 0.49% against the pound at 89.85 pence after paring earlier gains.

After a dramatic surge in British government bond yields in recent days, the Bank of England said it will from Wednesday carry out temporary purchases of bonds and postpone the planned start of its gilt sale programme.

The Bank said it had seen “dysfunction” in the market for long-dated gilts and that it would buy as many as necessary to rectify the situation.

UK assets have come under heavy pressure since Friday, when new finance minister Kwasi Kwarteng announced a swath of tax cuts to be funded by borrowing.

The pound dropped to a record low of $1.0327 on Monday, although it regained some ground on Tuesday to close at $1.0736.

The International Monetary Fund on Tuesday released a statement saying “we do not recommend large and untargeted fiscal packages” at the same time as monetary policy is being used to tackle high inflation. It suggested the UK government “reevaluate” its plans.

Ratings agency Moody’s also weighed in on Tuesday, saying the unfunded tax cuts were “credit negative” and likely to weigh on growth.

The BoE’s announcement triggered febrile trading in the currency markets on Wednesday, with the pound bouncing up and down before settling lower.

“This move from the Bank of England won’t stem moves against the UK debt and currency markets on their own,” said Mike Owens, global sales trader at Saxo Markets. “It’s a narrowly defined intervention that hopes to dampen the current shocks.”

The BoE said it would buy up to 5 billion pounds of bonds a day as part of its support package, and that it would begin on Wednesday afternoon.

Bond prices rallied sharply, driving yields lower. The yield on the benchmark 30-year gilt fell more than 80 basis points.

The FTSE 100 regained some ground to stand 0.45% lower.

“While this is welcome, the fact that it needed to be done in the first place shows that the UK markets are in a perilous position,” said Paul Dales, chief UK economist at Capital Economics.

“It wouldn’t be a huge surprise if another problem in the financial markets popped up before long. Either way, the downside risks to economic growth are growing.”

(Reporting by Harry Robertson; Editing by Amanda Cooper, Frank Jack Daniel and Catherine Evans)