British Pound in Flash-Crash Against US Dollar and Euro on Exchange Rate Markets - Why?

Services PMI will be watchedPound Sterling plummeted overnight with some calling it a 'flash crash' triggered in thin liquidity and some suggesting recent comments by France's Hollande as being the trigger

  • Pound to Euro exchange rate, 1 GBP = 1.1309, day's low: 1.0600, day's best: 1.1317 (Data from IG)
  • Pound to Dollar exchange rate, 1 GBP = 1.2468, day's low: 1.1800, day's best: 1.2614

A sudden crash in Sterling overnight has shocked global currency markets.

The Pound suddenly plummeted to 1.06 against the Euro and to 1.18 against the US Dollar when Asian markets opened.

We had quoted notably lower levels on the main pairs earlier but it appears the data provider we reference - IG - has made some manual adjustments to their quotes.

The declines represent a classic 'flash crash' - a big order that goes through in thin market conditions, the result of which are oversized moves.

Often automated algorithims can be behind such a move.

"Ostensibly triggered by harsh comments on UK exit terms from French PM Hollande, GBP collapsed around the Asian open, with trades apparently going through below 1.15. The move happened right at the point of thinnest liquidity and on a day (payrolls Friday) when volumes would have been unusually thin anyway," says Adam Cole at RBC Capital Markets.

Cole warns the nature of the flows that pushed GBP to the lows may not be clear for some time and for now and they are not changing forecasts, which are already well below consensus (1.25 end-year, 1.15 early next year).

Spillover into broader markets has been quite limited, but the tone is moderately risk-off (USD/JPY -40pts, AUD/USD -20pts).

“Apparently it was a rogue algorithm that triggered the sell off after it picked up comments made by the French President Francois Hollande, who said if Theresa May and co. want hard Brexit, they will get hard Brexit," says Kathleen Brooks at City Index in London.

“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 GBP," says Brooks.

Latest Pound/Euro Exchange Rates

United-Kingdom European-sUnion
Live:

1.188▲ + 0.13%

12 Month Best:

1.3218

*Your Bank's Retail Rate

 

1.1476 - 1.1524

**Independent Specialist

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Expect Further GBP Declines Today

This represents a dramatic extension to the October sell-off which has seen the currency look to fully absorb its 'Brexit premium.'

The 'Brexit premium' is the level traders are trying to find that reflects the UK economy's performance in the months around the actual Brexit event which is still over two years away.

"Amidst ongoing political uncertainty investors have to face up to assumptions of slower growth into ’17.This comes as we expect consumers to be compromised by reduced spending power. Such a combination remains a far from encouraging backdrop for external investors. Moreover ongoing question marks regarding the underlying monetary policy stance is set to maintain GBP negativity," says Jeremy Stretch at CIBC Markets in London.

Losses against the US Dollar are particularly acute as the USD is seen higher across the board thanks to a slew of better-than-forecast numbers being released over recent days.

As for the Euro, the team at UBS no longer look like outliers with their forecast for the EUR/GBP to reach 1:1 over coming months.

Pound bearishness shifted into a higher gear this week after the U.K. government weighed in on Brexit and signaled that access to Britain’s largest trading partner, the EU, would take a back seat to its higher priority of controlling immigration.

More latitude on immigration but less leeway on trade is seen as a more economically harmful route, dubbed a so-called ‘hard Brexit.’

"With Brexit uncertainty in the driver’s seat for the pound, it failed to enjoy much meaningful support for solid U.K. data this week on manufacturing and services growth. With bearish sentiment on the rise, the pound would be at risk of an accelerated slide should U.S. jobs data Friday reveal a ripening case for a Fed rate hike in the months ahead," says Joe Manimbo at Western Union.

Sterling's decline comes despite of strong economic statistics that would in ordinary times assist the UK currency higher, 

We have seen impressive readings come from the manufacturing and construction sectors this week, so expectations for a good reading from the services sector were high.

There are however questions over whether Sterling actually responds to data anymore; this could explain why even though the currency is off recent lows, it is hardly rocketing higher.

“Despite additional upbeat UK survey data, GBP is firmly on the back foot, as the market responds to the higher likelihood of a “hard” Brexit. GBP/USD broke through key long-term support at 1.2798, extending beyond support at 1.2720,” says analyst Robin Wilkin at Lloyds Bank.

Wilkin observes an interesting discrepancy in markets right now, which begs the question - is the prevailing sentiment more important than data?

“On the evidence of GBP over the last week, absolutely. Since mid-September, the correlation between the changes in the UK Citi Surprise Index and GBP/USD has fallen from +0.62 to -0.13, highlighting the extent to which the market is selling GBP despite the continued outperformance of domestic data,” says Wilkin.

Indeed, we saw Sterling's decline extend through key long-term technical support around $1.28 in spite of Markit UK Construction PMI surging to 52.3 - its biggest monthly gain since the survey began.

Wilkin however believes Sterling remains vulnerable:

“The bears are likely to maintain control for the coming sessions as the market has been abruptly awakened to the possibility of a 'hard' UK exit from the EU.”

August industrial output data will be released tomorrow, and are expected positive.

The release will be important as it will provide indications on GDP growth in 3Q, most at risk of a setback, and in which the BoE also expects a sharp slowdown.

UK Economy on Top

Despite the recent GBP weakness, there is still a mood of optimism in regards to the UK’s economic prospects.

Service PMI data from IHS Markit and the CIPS for September confirmed the UK economy remains comfortably in growth mode. 

The figure reported was 52.6 above 52.2 which was the number being forecast by analysts. However, it was lower than the previous month’s 52.9.

New business in the sector, which accounts for over 80% of the UK economy, rose at the fastest pace since February and the rate of job creation picked up.

The survey data signalled a strengthening trend in new business inflows, as companies reported new opportunities and customer enquiries, rising demand from overseas clients linked to the weak Pound Sterling and client confidence recovering after the initial Brexit vote shock.

“Across the three sectors, the pace of economic growth signalled was the strongest since January, fuelling greater job creation as companies shrugged off short-term Brexit worries and enjoyed the benefits of a weaker currency," says Chris Williamson, Chief Business Economist at IHS Markit.

When we take the construction, manufacturing and services data together we are left with the average level of the economy-wide composite PMI for Q3 consistent with GDP growth of about 0.2%.

"While this is a considerable slowdown from the 0.7% expansion seen in Q2, it is still better than most were expecting in the immediate aftermath of the referendum. And if the PMI remains around its current level then we could even see growth accelerate in Q4," says Paul Hollingworth at Capital Economics.

The IMF has forecast that Britain would enjoy the fastest growth of the major economies this year as growth slows for the other G7 nations.

This comes as the BoE’s newest policy maker Michael Saunders predicts better growth for the UK economy than even the BoE forecasts.

"This optimism from both Sanders and the IMF does not appear to be misplaced; whilst opinions on the UK’s economy in the face of Brexit vary, the BoE’s monetary policies and the apparent flexibility of the economy despite the falling pound suggest that there is the possibility of recovery," says Paresh Davdra at RationalFX in London.

However, Davdra believes it all depends on the ability of Theresa May and her government to convince businesses of this through a strong Brexit strategy.

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