Currency markets opened yesterday evening after a turbulent end to last week for the pound.
Sterling has slowly trundled steadily south since Britain’s decision to leave the EU. But last Friday sterling plummeted by six per cent in just two minutes during the early hours of the morning – it was dubbed a “flash crash”.
Just to recap, what actually happened?
Seconds after Asian markets opened, the pound fell from $1.26 to $1.18. Currency markets can move about, especially as different sets of traders turn on their computers but this huge movement came completely out of the blue.
The subsequent bounce back seemed to corroborate that someone, or something, somewhere had made a mistake.
Fun-loving forex traders are prone to enjoy a tipple or two. Perhaps unsurprisingly, therefore, Kit Juckes of Societe Generale surmised the situation as follows: “Sterling was drunk yesterday, went completely mad late in the evening and probably has a terrible headache this morning.”
Sterling ended the day down slightly at $1.24 having clawed itself back from whence it came, adding substance to notion that it was merely a glitch.
Do we know why it happened?
In short, not really.
“Absent anyone knowing what triggered the move lower, the ‘fat finger’ was put up as a culprit,” said Panmure Gordon’s chief economist Simon French. Someone punching the wrong number into a trade at least gives some comfort that it might have been human error rather than the next stage of the computers taking over forex trading world.
But technology was another explanation touted. Anyone who has read Michael Lewis’ Flashboys will know that a huge amount of trading is done automatically by computers. In a blink of an eye they place buy and sell orders based on complicated algorithms. Markets move in an instant, seconds after an event or news breaking.
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"These days some algorithms trade on the back of news sites, and even what is trending on social media sites such as Twitter, so a deluge of negative Brexit headlines could have led to an algo taking that as a major sell signal for the pound. Once the pound started moving lower, then more technical algos could have followed suit,” said Kathleen Brooks, a research director at City Index.
Another explanation posed was that the crash was a response to comments that surfaced in the early hours from French President Francois Holland. He told reporters the UK wanted to leave the EU "but doesn't want to pay" - something he said was "not possible".
What could have been a contributing factor to either one or all of the above was that there was comparatively low liquidity – how much money there is in the market at any one time – in the market. Low liquidity can exacerbate an underlying issue quickly.
Who’ll be looking into this?
As you might imagine, sharp fluctuations like this one do not go unnoticed. The Bank of England confirmed on Friday that it is investigating the flash crash. It is unknown how long it will be until it reveals its findings to the general public.
What next for sterling and could this happen again?
Without knowing the exact cause, it is hard to know for certain if this could happen again.
But Sean Callow, a senior currency strategist at Westpac, said that sterling had been “on a precipice” ever since Prime MInister Theresa May indicated at the Conservative Party Conference that the Brexit deal could end up restricting the UK’s access to the European single market.
Tom Elliott, an international investment strategist at deVere Group agreed.
“Currency markets are reacting to… the realisation that British Prime Minister, Theresa May, has opted for a risky ‘hard’ Brexit strategy,” he said.
Meanwhile, David Bloom, HSBC’s global head of FX, concluded that sterling is now “de facto official opposition to the Government’s policies”.
Elliott added a further reason that could weaken the pound. “There is the possibility of higher US interest rates and possibly lower ones in Britain,” he said. Lower interest rates tend to exert downward pressure on a currency. So with US and UK rates moving in opposite directions, there is the chance that the pound could weaken further.
Nevertheless Elliott doesn't think it is all doom and gloom. He concludes:
What should investors do? For the moment: Sit still and avoid knee-jerk responses.
Recent economic data from the UK has been stronger than had been expected in the wake of the 23 June referendum. Doom and gloom forecasters may continue to be proved wrong as a hard Brexit is negotiated.