"We are in no-man's land at the moment and the markets do not like uncertainty -- this is leading to a sell-off in the pound," said Currencies Direct dealer Phil McHugh.
Thursday's election has sparked the first official hung parliament since 1974, with the main opposition Conservatives garnering the most seats but with no chance of winning an overall majority, results showed.
In reaction, the pound tumbled to 1.4476 dollars -- its lowest level since April 2009 -- as it became increasingly clear that the Conservatives failed to clinch a decisive victory against the ruling Labour party.
"The pound has been crippled this morning by the spectre of political uncertainty," said Mark Bolsom, head of the UK trading desk at Travelex.
"A hung parliament really is the worst possible result for the pound and foreign exchange markets are very volatile.
"Investors are concerned that a hung parliament will paralyse the formation of a credible deficit reduction plan," he said, adding that many were seeking traditional safe-haven currencies like the dollar.
The British stock market also sank by one percent, slammed by sharp falls elsewhere amid mushrooming fears that the Greek debt crisis will spread across the eurozone.
Sterling later pulled back to stand at 1.4635 dollars at about 1030 GMT in choppy trading.
Traders worried that the uncertain outcome will affect the new British government's ability to slash its record public deficit and preserve the nation's top-level credit ratings.
However, international ratings agencies Moody's and Standard & Poor's said that the hung parliament verdict would not affect their top-level assessments.
Moody's said the unclear outcome "does not directly threaten" Britain's coveted AAA rating. S&P said that the nation's AAA long-term sovereign rating with a negative outlook was unchanged.
"The complexion of the new government is not, in itself, a factor for us," said S&P.
"Instead, out focus is on whether the government's fiscal consolidation plan to be unveiled in due course is likely or not to put the UK government debt burden on a downward trajectory over the medium term."
The opposition Conservatives won most seats but they failed to land a knock out blow against Prime Minister Gordon Brown.
With not many of the 650 seats left to be counted, the Conservatives had 291 lawmakers compared to 251 for Labour, meaning it was impossible for the Tories to win the 326 seats they need to govern alone in the House of Commons.
The Liberal Democrats had just 52 -- a disaster for the third party after what had seemed to be a strong campaign.
"It is now crucial to our economic recovery that the main parties agree on a credible plan -- indecision will threaten our credit rating and undermine the pound," added Bolsom.
Business leaders meanwhile labelled the hung parliament outcome a "political vacuum" and appealed for immediate action to show the way forward amid burgeoning worries about high level of public debt in the western world.
"It's vital that this political vacuum is filled as quickly as possible," said Miles Templeman, director-general of the Institute of Directors.
"The country simply can't afford an extended period of political horse-trading which delays much needed action to tackle the deficit.
"Politicians have postponed the difficult decisions on public spending cuts for too long already. Further delay will only jeopardise the future of the UK economy."
The new British government's priority will be to cut the deficit, which stands at 163.4 billion pounds (247 billion dollars, 189 billion euros), or 11.6 percent of gross domestic product -- the highest level since World War II.
Britain only just emerged from a record-length recession at the end of last year, ending a deep downturn that was rooted in the global financial crisis and lasted for six successive quarters.
Markets are currently on red alert over soaring levels of public debt after crisis-hit Greece was forced to go cap-in-hand to the eurozone and the IMF for a 110-billion-euro (145-billion-dollar) rescue package.
