Bank of England investigates flash crash as pound slumps

London

THE Bank of England announcement that it is investigating the remarkable 10 per cent flash crash of sterling, has raised expectations that the central bank will intervene to counter volatility. Regardless, the extent of sterling's devaluation since the Brexit vote has made British exports exceedingly competitive while at the same time prices of energy and other imports are expected to jump in the months ahead.

The events in the past 24 hours were an example of what currency analysts regard as extreme "overshooting" which renders predictions meaningless. Sterling slumped and then rallied within a two minute period during Asian trading hours when UK dealers were fast asleep and volumes were well below average. Perplexed traders and analysts believe that quantitative, high frequency computer programmes initiated sell orders as sterling breached stop loss orders within seconds.

The collapse that pushed the currency down to 1.13 briefly was a climax of a slide that began on Sept 6 when the pound was 1.34 against the US dollar. The brief low is not far above sterling's all time low of just under 1.05 against the US dollar in 1985.

The post-flash crash rally which pulled up the pound to current levels of 1.238, means that in a mere month the pound has slid by 7.6 per cent against the US dollar. Such has been the devaluation that the pound is currently 14 per cent below its purchasing power parity - a considerable depreciation on any scale and which illustrates that against the US dollar, the sterling is now undervalued on a trade weighted basis. This does not mean that the pound cannot fall further as investment and speculative flows determine short and invariably medium term (ie, several months) ranges of a currency.

The knock on effect of the pound against the Singapore dollar has been a slump from 1.81 early September to current levels of 1.696 following the brief flash crash Friday to 1.50. A year ago the rate was 2.20, so Singaporean exporters to the UK and foreign property investors there have been hurt, while imports from the UK are much cheaper.

The catalyst for the accelerated decline of sterling was precipitated by Bank of England governor Mark Carney's recent decision to slash the bank rate to 0.25 per cent and commence another bout of quantitative easing (QE); ie, purchases of government bonds to flood the financial system. In her speech at the Conservative Party Conference, UK Premier Theresa May issued a veiled criticism of the QE policy on the grounds that it hurts savers. The UK economy and manufacturing has outperformed the pessimistic forecast of "Remain" campaigners.

Under normal circumstances, these economic developments would underpin the currency. Instead the market has responded to political statements (which in truth are old news) that negotiations for Brexit will begin before the end of March, and threats of German and French heads of states that Britain will have to leave the single market if the UK rejects the free movement of labour.

In turn, hard line "Brexitiers" have said that they are prepared for Britain to go it alone and "break cleanly" from the EU as the majority of voters want the UK to have control of its own borders. As traders latched on to what was really old news, that "hard Brexit" could damage trade and the economy, the pound slipped below 1.30 and broke through key support levels of 1.29 and fell to new lows. HSBC is predicting 1.20 by the end of the year and 1.10 by the end of 2017.

Others are saying that sterling is undervalued. As latest events have shown, however, current predictions aren't worth the paper they are written on.