GBP: ‘Flash crash’ implications for the pound, May and the BoE - MUFG

Derek Halpenny, European Head of GMR at MUFG, notes that the pound plunged during the early part of the Asian trading session, hitting an intra-day low of 1.1841 according to Bloomberg pricing.

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“Although there is debate on that with the low possibly even lower, with one trading platform recording a low of 1.1378 – to the Bloomberg low it amounts to a 6.1% drop, approaching the scale of the move on the day Brexit was confirmed.

This of course has ‘flash crash’ written all over it and there is no logical fundamental justification to explain such an extreme move. There have been other examples of this with the South African rand suffering a near 10% plunge in January and this latest extreme move will do nothing for confidence in the market and may well reinforce the probability of this becoming a more frequent occurrence going forward. The greater share of the market that automated algorithmic trading takes in a less reliably liquid market, the greater the risk of these types of moves going forward. This will grab huge attention in the UK media of course and in a week when PM Theresa May is perceived to have laid out a ‘hard Brexit’ course for the UK leaving the EU, the government is likely to receive criticism.

So there are perhaps three implications in the aftermath of this pound ‘flash crash’. Firstly, whether justified or not, the government is likely to come in for considerable criticism in the press over the lack of clarity since the Brexit vote which will only intensify pressure on the government to get on with invoking Article 50 as quickly as possible and trying to reduce the element of uncertainty as quickly as possible. Also this may shape the internal government debate over the direction Brexit should take.

Secondly, ‘flash crash’ as this most likely is, it will no doubt still add considerably to the current negative sentiment for the pound. We argued in a Brexit update this week that the current sell-off is sentiment driven and that the fundamental backdrop for the pound was actually better than expected given the resilience the UK economy has shown since the vote. But sentiment can influence direction for some time before the fundamental backdrop exerts itself and this ‘flash crash’ leaves sentiment in the driving seat for pushing the pound lower still over the short-term.

Finally, I think we can put the idea of another imminent rate cut by the BoE to bed. A month ago, the positive fundamental story made us change our view from a rate cut to the BoE refraining from further action. While it can be argued that UK officials want a weak pound, we doubt the BoE would see the risk-reward of cutting as attractive in this environment and with confidence in the pound now so fragile. Recall also, Governor Carney’s infamous comment that Brexit would raise risks for the pound given the UK was dependent on the “kindness of strangers” for financing its record current account deficit. We did get good news on that last week with huge financing inflows from those “strangers” that easily covered the deficit but further monetary easing in the aftermath of today’s sharp pound plunge would be a risk too far – especially given it is not really needed now anyway in our view.”