The economic consequences of today’s UK Pound flash crash explained

Oh what a difference a couple of days make! It was only on Monday I wrote a post on here entitled ” Will this be seen as the sterling crisis of 2016?” and today we wake up UK time to see the UK Pound just above US $1.24 and at 1.12 versus the Euro. In fact this is not the half of it as the BBC points out.

The pound has dived on Asian markets with automated trading being blamed for the volatility.

At one stage it fell as much as 6% to $1.1841 – the biggest move since the Brexit vote – before recovering to $1.23, still down 1.5%.

It is not clear what triggered the sudden sell-off. Analysts say it could have been automated trading systems reacting to a news report.

There is a fair bit to consider and let me start with the debate over the basic facts as you see that it has also been suggested that the low was US $1.15 you get the idea. We saw this before when the Yen shot higher back in the day that there was considerable doubt to the exact numbers for a while. There are plenty of theories in the media that vary from unlikely to rubbish but Polemic Paine has written a good description of the way the market would have been.

But back to sales. Those that are still on the phone are quoting the reason for the fall on anything that they feel everyone else is saying because no one has a real clue. They will probably repeat what JPMChase or Goldman say as they reckon that the guys there are cleverer than them and more likely to know. So, clients will currently be being told that it is due to- “Barriers being hit at 1.25, 1.20 , and 1.15” and if they can’t even manage that will say “Stop losses”, which is a great generalised term that demands no justification. But some foolish folk will have done a Bloomberg News search for GBP and decided that it is due to the news that fracking had been allowed in North West England. Which is of course rubbish, because we all know that it happened because Diane Abbott was made the shadow Home Secretary.

For my own part I had a wry smile as only yesterday afternoon I was involved in a discussion about Goldman Sachs’ forecasting US $1.20 for the UK Pound which none of us realised was going to take less than 12 hours. My personal experience of such markets and I particularly think of the Italian bond market here is summed up again by Polemic Paine.

First, every salesperson is struggling to call all their clients who had ‘call levels’ at zones never expected to be hit, whilst trying to fill orders in systems at levels that they think they can get away with. Oh, hang on, no they can’t do that anymore as they need audit trails. So, they will all be huddled around spot desks arguing over whose order was hit at what……….Meanwhile, clients will be calling in demanding to know why their stops were done 7% below current market and why no one called them. Because if they had been called they would have bought it back at 8% below current markets because they are all retrospective geniuses.

Back in the days when the BTP ( Italian bond ) market swung wildly there was then a scramble to check stop-loss orders to find invariably that some had been forgotten in the melee. Because trading is now automated they should have been done except were ones that low even entered? Anyway a long day is ahead in dealing rooms just dealing with that and the recriminations. Meanwhile the media will have invented all sorts of stories which may or may not have any truth to them.

The economic impact

Much of this is uncertain and in fact the major initial impact is simply that uncertainty. This is the financial market equivalent of the night after the vote for Brexit as no-one will be exactly sure of what has just happened. However some things we do know as for example the UK Pound had been falling anyway and as I pointed out on Monday.

As we have fallen since then my estimate may now go as high as 1.5% for the boost to annual inflation.

We can add a little more to that if we stay here and of course there will be a boost to output but as I pointed out then it is much more difficult to quantify. This from the Market Purchasing Managers Indices is all we have so far.

rising demand from overseas clients linked to the weak pound sterling…….enjoyed the benefits of a weaker currency.

Another potential impact comes from the fact that due to more fears about inflation as discussed above the UK Gilt market has fallen heavily this morning. This is different to the UK Pound as it has lost some of its gains rather than adding to losses but if we continue like this there are two issues. Firstly the plan for an extended fiscal policy I discussed on the of this month as just got more expensive and secondly we may see some mortgage-rate rises. The prospect of the latter usually causes panic at the Bank of England in the same vein as Gollum in the Lord of the Rings worried about his precious.

To put this into numbers the 10 year Gilt yield has risen to 0.97% and for fiscal purposes the 30 year has risen to 1.68%. Both very low by historical standards but higher than they were.

Where was the Bank of England?

According to the Financial Times the UK Pound fell 6% in 2 minutes so we may ask where was the organisation which claims this?

Promoting the good of the people of the United Kingdom by maintaining monetary and financial stability.

It does have the ability to intervene and such a move is a clear case for intervention using this.

the Bank can intervene in support of its monetary policy objective using the Bank’s own resources rather than those of the EEA. (Exchange Equalisation Account).

As it happens it would have closed the position for a profit which is usually the case in such circumstances but not the reason for doing it. Does the Bank of England only work what used to be called gentleman’s hours?

Just as a pointer I have contacted them to say that the foreign reserves system is a mess and need reform. If I ever get a reply I will let you know.

Moving onto the economic position the Bank of England has its hands all over this and consequently a lot of egg on its face. What did it expect when it undertook Open Mouth Operations promising a monetary “sledgehammer”? Also I did point out on Monday that this statement from Dame Nemat Shafik could have been in the script for the film “Dumb and Dumber”

it seems likely to me that further monetary stimulus will be required at some point

Also there is the issue of this from Ben Broadbent of the Bank of England (h/t @LiveSquawk)

If sterling really starts to fall uncontrollably then it could have consequences for monetary policy.

And to be fair this bit turns out to be on the case.

the effect could be coming through faster than we’d anticipated

Having talked the UK Pound lower I suspect the Bank of England will be quiet for a bit or perhaps we will get some more like this from the FT about Governor Carney.

“In the absence of anyone else showing much economic leadership, this gives him a chance to shine,” said one Whitehall official. “He quite likes the media opportunities his current job gives him on the world stage.”

Right now it would involve yet another Forward Guidance U-Turn for him to support the UK Pound on the world stage.

Comment

There has been some economic news today which I will pick up in full detail another time as with markets in panic mode and the US employment report due later they will be ignored. Our persistent trade deficit persists and the small drop in monthly industrial production (0.4%) was more than explained by a fall in oil and gas (0.5%).

When this settles down we will have more idea of the full economic impact but I think John Lennon got it right all those years ago.

It’s been a hard day’s night, and I’d been working like a dog
It’s been a hard day’s night, I should be sleeping like a log

Those long the UK Pound may well have a different tune of his in mind though.

Help, I need somebody
Help, not just anybody
Help, you know I need someone, help

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47 thoughts on “The economic consequences of today’s UK Pound flash crash explained

  1. Hi Shaun

    I detect a sea change in the mood music over the past week or so.

    It’s not just May’s speech about the equivocal results of monetary policy and the penalties to savers, it’s a somewhat more overt criticism of the BOE (see John Redwood’s blog)to the point where many are saying that they simply have it wrong – as you have been saying for some time.

    I can’t see that a rise in gilt yields and a substantial rise in inflation with a huge trade deficit in the background is other than baked in and this puts the BOE in a very difficult position. I think they will find it very difficult to “look through” inflation a second time; on the other hand an IR rise would tank the economy so it’s a question of pick your poison.

    I voted for Brexit partly in the expectation that we would have a fall in sterling which, among other things, would deliver a (hopefully) cathartic shock to the economy and help get us away from one built on debt and speculation to one built on enterprise and savings and I hope this is still the case.

    With folk like Carney in charge, the ultimate backstopper of the borrowing tendency, I can’t see this happening. However, with Lagarde in court shortly there may be a vacancy at the IMF which Carney could fill, in which case he will then have the opportunity of wreaking his depredations and being consistently wrong on a larger stage.

    • ‘I voted for Brexit partly in the expectation that we would have a fall in sterling which, among other things, would deliver a (hopefully) cathartic shock to the economy and help get us away from one built on debt and speculation to one built on enterprise and savings and I hope this is still the case. ‘

      Succinctly put Bob.

      And you have Remainers running round calling people stupid for being a leaver.

      ‘However, with Lagarde in court shortly there may be a vacancy at the IMF which Carney could fill, in which case he will then have the opportunity of wreaking his depredations and being consistently wrong on a larger stage.’

      Love it.

    • “I can’t see that a rise in gilt yields and a substantial rise in inflation with a huge trade deficit in the background is other than baked in..”

      Trade deficit was 2.6% in Q2 of 2016, close to it’s average of 2.4% over the last 15 years – http://static1.1.sqspcdn.com/static/f/153565/27279877/1475840255647/161007-chart1.gif?token=dLSvuWOIQoGGP8xCj4p7xOyzKcw%3D.

      So why should gilts and inflation suddenly shoot up now? More likely other inflationary pressures at play as oil price falls drop out of the stats and commodities make a small recovery, whilst the pound had already fallen due to uncertainty caused by Brexit which provides a very strong inflationary push and in turn will automatically drive yields up.

      Secondly, we have the macho machismo talk at the Conservative Party conference about Brexit whilst simultaneously talking about fiscal loosening in addition to further unwarranted monetary loosening and QE by the BOE post Brexit. All this adds up to foreign investors taking fright and pulling their money out thereby crashing the pound which has been ongoing since June.

      Given the authorities like inflation this has likely been a carefully orchestrated move and I see no reason why the they should not ignore 3% – 4% pa CPI next year.

      Still, at least the ftse 100 will do OK with all those companies in it bringing their substantial foreign profits back to the UK and converting them into a depreciating pound.

  2. Another Beatles’ song for those long on £:
    You tell lies thinking I can’t see.
    You can’t cry ’cause you’re laughing at me.
    I’m down. (I’m really down)

  3. All the talk above about stop losses/trading desks/call options etc does remind me that there are two separate universes:
    1. The real world, where people actually do things, pay taxes, pay bills; and
    2. The absurdly overpaid and utterly pointless world of people tapping computers to drive money around and around, deriving huge bonuses for absolutely nothing. Making money out of currency volatility is about as stupid a day job as I can think of.
    And, in the middle, we have the BoE, manipulating markets through QE etc in a way that simply adds to the riches of the bank kleptocracy.
    How did we get here?

    • ‘deriving huge bonuses for absolutely nothing.’

      As you allude they are actually milking tax payers and future generations,so technically,not doing nothing.

      • If I did it , it would be called fraud or theft – make it a business model and it becomes respectable …..

        Forbin

        Ps: spivs I think the term is ….

    • I think I am becoming paranoid about this as my first thought was that the crash was orchestrated by the evil empire (EU) as the beginning of punishment for having the temerity to upset their plans with Brexit.

      • Hi Pavlaki,
        You can relax. The evil empire is in no way organised enough to do this. You’d have to get 27 countries to agree and, at present, getting five of them to agree the day of the week seems beyond them.

        • Unfortunately they all seem to agree that they are going to give the UK a hard time in negotiations – even if it goes against their own best interests for continued trade and business in the U.K. I used to think that no one would be that stupid but I’m not so sure now. They are showing their true colours now which makes me think we did the right thing. Friends like these……?

        • We may not need the European politicians to deliberately wreck the UK economy as the BBC is doing the job for them. I have just watched the interview between Le Pen and Stephen Sakur on hard talk and he is basically saying that the UK post Brexit vote is a disaster. Again – with friends like these……! Except this time it’s our own 5th column.

    • How did we get here?

      In 1979 a “lady” called Margaret Thatcher was elected as Prime Minister. She disparaged anything that created real value and promoted a “Service based economy” mainly based on Financial Services where people sell houses and savings vehicles to each other but create nothing of any use.

      In creating this imbalanced, specialised and non diversified economy, she ensured that one day, when all the family silver producing things that people used and which made income was sold off (Gas and Electric supply, water supply etc) and there was nothing left to fall back on the UK would collapse. Welcome to her legacy!

      • They were losing money, hardly family silver – more like a liability. Nationalized BT had a 6 month wait for a telephone line and this came down under 2 weeks with privatization.

        Thatcher did oversee Nissan’s FDI into UK auto manufacturing. British Leyland sucked subsidies, Nissan pays tax. Various politicians went badly wrong when they declined to sell Rover to Honda.

        It was Gordon Brown who ‘Saved the (banksters) world’ amid counterfactual claims that the alternative was global financial meltdown. Iceland let the bad banks go broke and didn’t meltdown – which suggests to me that Gordon was conned by failing banksters at taxpayers expense.

        Profitable financial instutions pay tax, unprofitable finanical institutions don’t deserve subsidy.

        • Electric and Gas made money. I didn’t mention BT but as you have brought it up, it took BT 10 YEARS before it provided the service you speak of whilst prices remained extortionately high although it did eventually become price competitive ,but after far too long a wait. At the time her “story” was that we would have unlimited choice, high quality and cheap prices. This never happened in the energy or water industry where oligopolies rule to this day.

          British Leyland had to go but Rover was also a basket case as it was no longer the quality marque it had been in the 70’s .

          Agree Gordon Brown but who created the environs for this to happen back in the 80’s with her abolition of the formula embedded in the Consumer Credit Act of 1974 stopping people from borrowing more than they could afford and her relaxation of fractional reserve banking requirements from 12.5% to 2%, backing it all up with her “people are not lemmings, they know how much they can afford to borrow” speech?

          As for the profitable institutions comment, exactly why did she keep subsidising the massive loss making Nuclear industry? You have confused sensible business practice with political dogma.

        • I’d agree the current energy oligopolies are disappointing. I’d call it a regulatory and politcial failure – with all concerned (Thatcher, Major, Blair, Brown and Cameron govt’s) failing to act on a cartel.

          I had not commented on nuclear power subsidies. I suspect Maggie kept them for military reasons, to provide fissile material for atomic bombs. As per Shaun’s guidelines – I avoid party politics on this site and criticise policies.

          State run reactors suffer a conflict of interest. The state is responsible for both safety regulation and reactor operation. Though I note that the supposedly independent Japanese nuclear regulator failed badly.

        • Thanks for the reply on Nuclear, I didn’t think of that, you’re probably right.

  4. Hi Shaun, your whole week of material has been very conveniently relevant. I foeecast that immediately the UK coise to make some infrastructure investment then suddenly the zero percent inteest rates may prove a mirage.

    The FT commenters are beside themselves, very ready to pin blame on the utterances of Teresa Dismay for their FX disaster as “computers” pushed sterling into lows never even considered for their clients. They hate the unpredictability.

    It appears to me that the reset could have been triggered. Forbin should buy his dollar denominated corn now, whilst he can still afford it. Lets face it the UK has victorian infrastructure that is way over-priced, once you kick out the foreign students or stop the established rentier state then the whole place is “in question”. We have a budget and current account deficit only rentier and city income to pay for it.

    The mistake by Teresa Dismay was to show compassion and fairness. It is rocking the state literally. And she has even done anything, only voiced words of a politician.

  5. Hi Shaun
    I woke early morning and was “surprised”
    at the news but shocked at Sky and BBC’s lack of
    coverage.
    I have just read part of the findings with
    regard to the market events of may6th 2010.

    However, on may 6th, when markets were still under
    stress,the Sell Algorithm chosen by the large trader
    to only target trading volume. AND NEITHER PRICE
    NOR TIME,executed the sell programme extremely
    rapidly in 20 minutes.

    https://www.sec.gov/news/studies/2010/marketevents-report.pdf

    Is something similar likely to have happened today?

    Will a future algorithm be the ultimate cause of, as REM put it,

    “The end of the world as we know it.”

    • JRH never be surprised at the misinformation and omissions of our media it is partly responsible for the state this country is in.

    • Hi JRH

      It seems like that but what it probably did was trigger some stop losses which it would appear came from some hard to predict sources.

      http://www.bbc.co.uk/news/business-37588020

      However there are stories that this was more due to selling volatility ( for those who do not know what this means it is selling risk using options) than anything to do with the sports business. Also Easyjet put out a statement.

      So we may have a move in a quiet market which kicked off stops and we are left to wonder if it was deliberate or just chance.

      Meanwhile the Bank of England was taking a nap….

  6. Do not worry – we are all saved. Tony Blair has said that he might consider a new role in British politics.
    Hallelujah!

  7. ‘Those long the UK Pound may well have a different tune of his in mind though.
    Help, I need somebody
    Help, not just anybody
    Help, you know I need someone, help’

    So that’s the whole (99.9%?) of the UK population then. And they would be thinking the BoE is looking after their interests?

    Pity that M & M have both been talking down the pound for years then.
    Bit odd really, having a RPI linked £ pension and throwing currency risk at it like that …

    • Hi DL

      There is or I should say was the issue at the Bank of England of members of its pension scheme being exempted in retirement from any inflationary issues. These days newer staff including Governor Carney accrue benefits which are not as good as they were although still better than the vast majority.

  8. On your twitter site you noted a wave of selling coming in at a certain time this morning. Tsunami like, i.e., from a relative calm to big waves. They all happen about the same time. So, where from.

    • Hi am

      That drop into the low US $1.22s and so was probably margin calls in the US. A bit of heavy selling and the price being moved away from them and hey presto! With the Pound now at US $1.244 as we approach the end of the trading day that does not seem a cunning plan but on this of all days we cannot be sure until the end of it.

  9. Hi Shaun
    Given the timing and the continuing lack of suport today, I strongly suspect the ‘fat finger’ was the BoE itself. It would know exactly when liquidity was at its lowest and have a fair idea of the algos in place in HK and London.
    In one fell swoop the price effect of tariffs on services has been removed, and the tariffs on imports such as French food ( 40%) has increased 50%. Take the hit now before negotiations start. In the same way, get inflationary impacts now , gilt yields rising, interest rate increases etc etc well before the next election.
    If I am right, its just possible that we could have a government trying to get the economy back through the looking glass. Or maybe I should keep taking the pills!
    I do find it somewhat amusing that the european politicians talking the ‘hardest’ about the EU stance on negotiations are highly unlikely to be round the negotiating table.

  10. Great blog as usual, Shaun. I read Ben Broadbent’s speech too. The Deputy Governor in charge of Monetary Policy was surely derelict in his duty in not stating just what kind of a drop in sterling would have led the MPC to raise the bank rate instead of lowering it following a vote to leave the EU. I suppose if the pound keeps dropping we will find out. The copycat forward guidance regime Calamity Carney introduced at the Bank of England in August 2013 lasted all of six months. I wonder if the monetary easing policy he introduced almost precisely three years later will even last that long.

    • Hi Andrew

      I think that a bit like with Forward Guidance Ben Broadbent was trying to place an impression and that he had neither thought through at what level he would change policy nor what rate of fall. I do not think that he is important enough to have triggered the fall itself but a general view that the Bank of England is unlikely to respond due to its Open Mouth Operations was no doubt in the mix.

      If they had to reverse course then we may need to import some eggs as all of their faces will have to be covered.

  11. The incompetence of the politicians and their economic policies over the last 3 decades have been disastrous yet around 35-40% of the population must support debt slavery cradle to grave.
    University Education ,tens of of thousands of pounds – Home Ownership ,hundreds of thousands of pounds, Occupational Pensions -destroyed.
    The people have been misled it is not the fault of the EU ,UKIP and the Tories said Brexit will result in the land of milk and honey the SNP said Scottish independence would lead to the same destination.
    The pound will continue to fall and sooner or later Brexit will look much less enticing to much of the population,we have £1.6 T of Government debt and around the same in private debt ,what effect is a plummeting pound going to have on the debtors?
    The disciples of Goebelles who are the main stream media have so far been pedalling the mantra that this is good for exports….the problem is we import much more than we export.
    There will be trouble ahead.

    • Is a lower currency good for exports, that is open to question. Good for the balance of payments, yes because Brits will be too poor to afford imports. The most unpleasant part will be the rises in imported food costs, which will show in lower purchasing power.

    • “The people have been misled.” equates to “The people are thicker than I, because I’m right.”
      Arrogant rubbish.

  12. Hey Shaun, I was one of those people responsible for the mad swings in BTPs. Remember the old LIFFE after hours trading system, APT? I had a 1300 lot stop for a US client – warned him, but he insisted. Blew the lights out when it triggered, LIFFE had to bust some of the trades the move was so violent. Those were the days. Good analysis, btw, really feels like it is coming to a head. Strange people don’t connect our trade deficit and the need for a correction of some sort.

    • Hi Joss

      You are reminding me of some of those days. When I worked at Deutsche they had recently bought Banca D’america e D’Italia or BAI. What that meant was we got loads of small lot orders some of which came with stops. In a fast moving market they were a nightmare as on the LIFFE Floor the main booth did BTPs and Bunds and if both were busy who would remember a 2 lot stop?

      One of my favourite memories is when the DB floor manager announced on the phone lines that every order was filled when we did not even know every order we had! Meanwhile APT worked pretty well and should have been invested in and developed.

    • Isn’t this trade deficit correction business very short-term? GBP/Euro goes down because of deficit in goods which may no longer be balanced by services and inward investments if no access to single market. But the decline itself reduces imports and there are other ways other than single market membership that give at least some access to services. Thus GBP/Euro rebounds, and that doesn’t take into account possible/likely (?) problems for Euro with Italy etc.
      A quick analysis of real US economy shows its pretty ropey. The overall jobs numbers hide the truth about reduction in manufacturing jobs and rise of ‘waiters’. Decline of full-time hiden by rise of part-time. I used to thing the Fed would raise rates first, but now it may be the BoE doing ‘the unthinkable’. Cable may rebound quicker than most think.

      • Hi JW

        This move has many of the signs of a climax to the move down. However lows like that often get retested again before a change in trend. That is awkward in the sense whilst some say US $1.18 other have claimed US $1.15 and even US $1.13 for the drop. That matters in the sense that the chartists may have seen their patterns completed.

        One of my earlier texts was Rudiger Dornbusch on exchange-rate overshooting which the UK Pound has always been prone to.

        • Hi Shaun
          Of all the bank forecasts of cable over the next year or so, there is one outlier, the Canadians. They forecast 1.35 by ye2017 on a rising trend. Now I wonder where they got that idea from………

    • Hi, I would have been on the other side, busting your trades, as the LIFFE Official in charge of APT. Those APT and subsequent CONNECT liquidity shortages, were always driven by stops at key support\Resistance levels, where the large volume of stops, was simply to great for the resting orders to soak up. I have no doubt that the latest flash crash was caused by the same forces. I find it incredible that the focus as always is on the nature of the participants rather than the poor design of the trading platforms. Eurex, solved this problem many years ago, with their Volatility Interrupt system – if a market moves more than a set amount they put it in ‘auction’ thus giving the participants an opportunity to provide liquidity. A half page memo from the regulators mandating all platforms to have a similar system, would consign these these events to history, where they long since belong.

  13. Pingback: Weekly Roundup, 11th October 2016 - 7 Circles

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