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Bank of England investigating dramatic overnight fall in pound

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Potential causes of sterling flash crash that compounded earlier losses include fat finger error and computer-generated trade

The dramatic collapse in the pound overnight is being scrutinised by the Bank of England amid suggestions that a fat finger error or computer-generated trade was behind the slide in sterling to a new 31-year low.

The trading incident appears to have lasted for about four minutes in early Asian trading on Friday, compounding the losses that sterling had already suffered following speculation that Britain is heading for a hard Brexit.

The Bank, which had been on alert for the impact of computer trading on markets, said: We are looking at the causes of the sharp falls overnight.

The pound dropped by 6% to $1.1841 in Asian trading, with traders left puzzled as to the cause. At one stage, the pound was down by as much as 10% to $1.1378, until a rogue outlying trade was cancelled, leading to a recovery. It regained some of its losses and was down 2% at $1.2363 ahead of the US markets opening on Friday.

Fall in the pound

While traders continued their postmortems, the HSBC strategist David Bloom said: The currency is now the de facto official opposition to the governments policies.

To us, the foreign exchange market is exhibiting an uncanny resemblance to the five stages of grief. First, following the Brexit vote came the denial theories circulated whether a second referendum would have to take place. Second was anger claims the vote was unfair. Third was the bargaining arguments maybe it wouldnt be that bad, what if the UK followed the Norwegian or Switzerland model. Now, the fourth a gloom is prevailing over the pound.

Its become an uncomfortable reality to the market, post the Conservative conference, that the UK will embark on a hard Brexit.

Bloom said he expects the pound to be at $1.10 by the end of 2017.

The fall in sterling helped propel the FTSE 100 higher by 75 points by 10am in London, a rise of 1%, taking it to 7,075. The blue-chip index tends to rise when sterling falls, because most of the constituent companies earn the majority of their money in dollars, rather than pounds.

As the currency rallied, there was speculation that a technical glitch or human error had caused a flurry of computer-driven orders.

Naeem Aslam, the chief market analyst at Think Markets, said: What we had was insane call it flash crash, but the move of this magnitude really tells you how low the currency can really go. Hard Brexit has haunted sterling.

The Bank has previously highlighted the impact of trading algorithms. Some markets appear to have become more fragile, as evidenced by episodes of short-term volatility and illiquidity over the past couple of years, Threadneedle Street said last December.

Potential drivers of such episodes include a broad trend towards fast, electronic trading and the impact of necessary regulatory reforms on the provision of market liquidity. Overall, there is evidence that the level of liquidity in normal times has declined in markets that remain reliant on dealers to intermediate between clients.

Algorithmic trading explainer

The foreign exchange market is largely unregulated, but policymakers will want to know the reasons for the sudden currency move. One theory is that dealers, or computer trading systems, were reacting to a Financial Times article in which the French president, Franois Hollande, said Britain would have to suffer for the Brexit vote in order to ensure EU unity.

Some algorithms have been designed to feed off news headlines and social media, meaning that the programmes can be affected by human factors.

Hollandes comments at an EU dinner in Paris came after the British prime minister, Theresa May, hinted that the UK was moving towards a Brexit deal that could restrict its access to the European single market, but provide greater control over immigration levels.

The pound has fallen by 13% against the dollar since Britain voted to leave the EU on 23 June. The losses accelerated after May announced on Sunday that she would trigger article 50 by March 2017, beginning the UKs formal exit.

Sean Callow, a senior currency strategist at Westpac, noted that sterling had been on a precipice since Mays speech at the Conservative party conference.

I think weve underestimated how many people had money positions for a very wishy-washy Brexit, or even none, he said.

Speaking in Hong Kong on Friday, the Conservative MP Mark Garnier, a minister at the Department for International Trade, said: Clearly its [the falling pound] to do with the [Brexit] vote, but actually its not an unwelcome reaction. Sterling is probably about where it should be. Were just going through a relatively short period of volatility.

Weve probably found stability at this level. What we dont want is to see it jumping around 5% on a weekly basis nobody wants their currency to be volatile.

Read more: http://www.theguardian.com/us

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