Just after midnight in the UK on Friday morning, when most of Europe was asleep, foreign exchange dealers in Asia were jolted out of their routine contemplation of the currency markets by a sudden, inexplicable plunge in the value of the pound against the dollar.
The UK currency had been under renewed pressure since Sunday, when Theresa May said she would trigger article 50 by next March and hinted at a hard Brexit – putting immigration controls at the forefront of EU discussions at the expense of remaining in the single market. With investors worried about the subsequent outlook for the UK economy, the pound had already dropped to a new 31-year low.
But at 7.07am Hong Kong time on Friday, when traders were just starting work and little business is usually done, sterling suddenly fell off a cliff.
It dropped more than 8% from $1.26 to $1.1491 in just eight minutes – a huge plunge in a market where a single cent is a big change. Dealers said there were only a small number of trades, possibly just a few hundred, made during that time. At one point the fall looked even worse, down 10% to $1.1378, before the cancellation of what was said to be a rogue trade.
Even so, the slump was undeniably the worst one-day drop since the 10% fall in the immediate aftermath of the result of the Brexit vote in June.
After several minutes of chaos on the trading floors, a semblance of calm returned and buy orders started to come in. Just 30 minutes later the pound had recovered to $1.24, but shell-shocked traders were scrambling to find a reason for the sudden “flash crash”.
“I’ve been trading the pound since 1978 through every crisis it has seen, and I’ve not seen anything like this,” said Ian Johnson, a foreign exchange strategist at financial analysis firm 4Cast.
Naeem Aslam, the chief market analyst at Think Markets, said: “What we had was insane. Call it a flash crash, but a move of this magnitude really tells you how low the currency can really go. Hard Brexit has haunted sterling.”
The falls will have hit both investors and companies. Sports Direct issued a profit warning on Friday afternoon, saying the overnight flash crash had cost the company £15m, or 5% of its annual profits. .
It was not long before theories began to emerge. The most popular was that computer-driven algorithmic systems – known as algos – were the cause because they are programmed to sell the pound on negative Brexit headlines. According to this theory the algos had picked up on a report in the Financial Times quoting the French president, François Hollande, as saying that Britain would have to suffer for the Brexit vote in order to ensure EU unity.
Kathleen Brooks, the research director at the financial betting firm City Index, said: “Apparently it was a rogue algorithm that triggered the sell off … These days some algos 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, compounding the short, sharp, selling pressure.”
The FT said its report was published seconds after, rather than before, the pound’s fall began. Even so, many prominent City figures believe computerised trading was behind the fall, with programs called Cowpox and Triple Threat mentioned as possible instigators of the slide.
Earlier there had been speculation that the fall was due to a “fat finger” trade, where a dealer types an incorrect figure into their terminal, which could also have set off the computerised sell programmes. Dealers pointed out, however, that such trades would have since been cancelled if that were the case.
Others said the fall may have been linked to a technicality, the expiry of foreign exchange options on Friday, with banks hedging their exposure to anticipated currency movements. On top of that, major institutions often have instructions in place to sell investments if they fall below a certain level, and some of these so-called stop-losses could have been triggered by the sudden plunge in the pound.
A definitive answer may never emerge, because the foreign exchange market has no central trading system, which makes it difficult to track deals. The Bank of England, which had already been on alert for the impact of computer trading on markets, is investigating. It said: “We are looking at the causes of the sharp falls overnight,” and later added it had asked the Bank for International Settlements – which represents the world’s central banks – to look into what prompted the flash crash.
Sterling struggled to regain ground during the day, but recovered to $1.2461 after worse than expected US employment figures hit the dollar. Analysts expect the currency to remain under pressure thanks to the uncertainty around Brexit – and they said another sudden drop was not out of the question.
Brooks said: “This highlights the drawback of machines making trading decisions. However, it is the reality, and it is only getting more popular. Thus, another flash crash is possible. If there is , the pound is vulnerable because such unstable forces are driving it.”
Sean Callow, a senior currency strategist at Westpac, said that sterling had been on a precipice since May’s speech at the Conservative party conference. “I think we’ve underestimated how many people had money positions for a very wishy-washy Brexit, or even none,” he said.
Speaking in Washington, the British chancellor, Philip Hammond, said: ,“It has taken us a little while to persuade the markets and investors that Brexit will happen. This week the final foot dropped. Those who thought it is not going to happen have taken on board that it is going to happen.”
Hammond said he did not expect market turbulence to drive the pound consistently lower. Accepting that there would be “bumps in the road” during the negotiations, he said the currency would have ups and downs as people weighed up the opportunities as well as the costs of leaving the EU.
The HSBC strategist David Bloom said he expected the pound to fall to $1.10 and to parity with the euro by the end of 2017. Analysts at the Japanese financial group Daiwa were more pessimistic: “Sterling’s all-time low against the dollar was $1.05. If the government keeps careering headlong into a hard Brexit, a return to those lows is not unimaginable.”
So bad news for sterling, and holidaymakers, with or without another flash crash.