LONDON – The British pound endured one of its biggest falls ever on Friday – with some in the markets blaming trading robots or a fat-fingered typo for sending the currency down a precipitous 6 percent in just a couple of minutes.
For one of the world’s major currencies, which is held as a reserve by countries around the world, that’s a huge move, matched only by the pound’s fall in the wake of dramatic events like Britain’s June 23 vote to leave the European Union.
Early Friday during Asian hours, the pound tumbled from $1.2600 to as low as $1.1789 in the space of two minutes, according to financial data provider FactSet. It recovered since that cliff-like fall to trade at $1.24 later Friday. Still, that’s a level the currency hasn’t seen since 1985 and way down on where it started the week, just below $1.30.
The crash occurred during a “twilight period” in the markets – after the close in the U.S. and just as Asian traders were starting their day. That means the volume of trading was likely lower than usual, when relatively smaller trades can have an outsize impact.
Various reasons have been cited for the drama involving one of the world’s oldest currencies. Some say a trader made a “fat finger” mistake while typing in a market order. Others say it could have been an automated trading algorithm that makes decisions based on news websites or social media, or comments by France’s president, Francois Hollande, who said Britain should pay for its decision to leave the 28-nation EU.
It could be combination of them all – the Bank of England is investigating.
“Investigations are underway but a single reason may never be identified for last night’s `flash crash’ ”, said Mike van Dulken, head of research at Accendo Markets.
The move triggered reminders of the “flash crash” that the Dow Jones index in New York suffered on May 6, 2010, when it dropped 1,000 or so points in a matter of minutes. Several potential causes have been cited for that crash. One involves a British financial trader operating from his parent’s home in west London – Navinder Singh Sarao, the so-called “Hound of Hounslow,” who is still fighting extradition charges to face trial in the United States for fraud and manipulating the market. Sarao denies any wrongdoing.
The difference with that Dow descent is that the pound is already in the doldrums, posting a series of new 31-year lows against the dollar this week as traders fret over the uncertainty surrounding Brexit, the British departure from the EU. Although the British economy has held up better than expected in the immediate aftermath of the “leave” vote, there are great long-term uncertainties surrounding the British economy.
The main worry in the currency markets centers on what a clean British break from the EU, which is looking like the preferred option of new Prime Minister Theresa May, would look like.
May this week said she would invoke by the end of March Article 50 of the EU treaty, the mechanism by which two years of talks on Britain’s exit officially commence. She also appeared to signal that her government would prioritize controls on immigration over access to the European single market, an approach informally called a “hard Brexit.”
The impact of leaving Europe’s single market could be felt far and wide in Britain. London’s pre-eminent financial services companies would lose automatic access to operate in the other EU countries. And foreign firms like carmaker Nissan could halt investments or even abandon their British bases in favor of new ones within the European single market.
Jane Foley, senior currency strategist at Rabobank International, said the heart of the pound’s problems, regardless of fat fingers or robotic trading, is concern over this “hard Brexit” approach. She said the outlook for investment “looks likely to sour” if the country is out of the single market.
“Since the U.K. runs a significant current account deficit – 5.3 percent of GDP in 2015 – the pound is heavily exposed to downside risk on a drop in investment flow,” she said.
History shows that British governments have often changed tack due to sharp movements in the currency markets. In 1992, the British pound suffered similarly dramatic losses as it crashed out of a fixed exchange-rate system that was then operating in Europe. The government then abandoned the Exchange Rate Mechanism and ploughed a new economic path.
Britain has a floating currency now, so the impact on the country isn’t as acute – a drop in the pound helps some parts of the economy, like exporters. But if the pound falls much further, say toward a 1-to-1 value with the euro or the dollar, then the pressure may turn more acute on Britain’s Conservative government.
Friday’s temporary crash has probably added to worries over the currency and that could prompt further selling in the days and weeks ahead, regardless of what the underlying British economic data suggests.
“The pound pushing `on an open door’ looks like a pathetically weak description of a house that has lost its foundations,” said Alan Ruskin, a senior foreign exchange strategist at Deutsche Bank.
Ruskin added it is “far from clear that the slump is nearly over, now that the financial markets have laid out a challenge to the U.K.’s leadership on their latest `vision’ of Brexit.”
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