Pound sterling ‘flash crash’ fuels bearish calls of more weakness for UK currency

It has not been a great week for sterling, with the currency taking a further pounding overnight and diving to a fresh 31-year-low in mysterious circumstances, amid analyst forecasts for more uncertainty to come.

“It is still early days to determine the end-result (of Brexit) but one thing seems certain: Sterling will remain under severe pressure. We reiterate our forecast for GBP-USD at 1.20 and EUR-GBP at 0.93 by year-end,” Vasileios Gkionakis, head of global FX strategy at UniCredit Research, told CNBC Friday.

The coup d’état for the currency came during the Asian trading session when the pound tanked as much as 6 percent, falling to 1.1819 against the dollar, the lowest level since 1985.

Analysts cited a variety of possible reasons for the sharp decline in the currency – from a so-called “fat finger” or algorithmic (known as algos) trading error, to a low liquidity sell-off or even comments from French President Francois Hollande. But traders could not pinpoint the exact reason for the plunge.

Nonetheless, analysts believed that more volatility was in store for the currency, given the U.K.’s uncertain future political and economic ties with the European Union since its decision in June to quit the bloc.

Speaking on the sidelines of the International Monetary Fund and World Bank annual conference in Washington, Australian finance minister Scott Morrison warned against prolonged volatility in the currency markets.

“Well if these things are enduring, obviously that’s an issue,” he told CNBC.

“Volatility is a pretty short sharp shock and a normal transmission is thereafter resumed. So I think it’s very important that people don’t overreact to this or that and look to the longer term view.”

A vision of things to come?

Jane Foley, senior currency strategist at Rabobank, told CNBC in an email that “fat fingers, algos, low liquidity may all have been factors but it is possible that the move was exaggerated by the current vulnerability of the pound and the forecasts of some investors and economist that GBP still has further to fall as Brexit consequences come home to roost.”

But Kathy Lien, managing director of foreign exchange strategy at BK Asset Management, said the rebound from Friday’s sell-off could be “violent.”

“It’s a low liquidity sell-off. Typically when we see this, the reversal is violent but with fundamental support, the pound could find a new range between 1.22 and 1.25 per dollar,” she said in e-mailed comments.

The pound started the week as it meant to go on, falling sharply against the dollar and euro after the U.K. Prime Minister Theresa May gave a clearer indication of when the country would begin the formal exit process from the European Union, saying “Article 50” would be triggered before the end of March 2017.

Things got worse for the currency after a range of ruling Conservative party politicians signaled on Tuesday, during Conservative Party conference speeches, that the U.K. government could adopt a “hard Brexit” policy – a more uncompromising stance during exit negotiations with the EU, rather than a “soft,” more conciliatory tone.

Friday’s moves were the most dramatic, however, and although the currency has now recovered to trade at 1.2434 against the dollar, it is still 1.4 percent lower against the greenback. Since the start of the week, the currency is down almost 3.9 percent against the dollar and down 3 percent against the euro.

Sterling-dollar parity on the horizon?

Despite some increasingly bearish calls on sterling looking ahead, analysts were far from convinced that sterling-dollar parity was looming.

Jeremy Stretch, head of G-10 FX strategy at CIBC Capital Markets, put the likelihood of parity at 1/20.

“A relatively moderate chance to put it mildly,” he told CNBC in a phone interview.

Even Rabobank’s Foley – who is bearish on sterling – said that sterling-dollar parity “seemed a long way away.”

Meanwhile, Ashraf Laidi, CEO of independent strategist Intermarket Strategy, said that at worst, he would expect sterling to fall to 1.10 or 1.11.

“Another important point is that it would be unsustainable for the U.S. economy to have a USD as strong as this case (parity) would imply,” he told CNBC in a phone interview.

Since the referendum in June and the initial market shock in response to the unexpected vote to leave the EU, global markets have been largely agnostic towards the U.K. and its currency, especially since the U.K. has yet to formally trigger “Article 50” which sets the Brexit process in motion.

Gkionakis at UniCredit Research told CNBC that regardless of the exact reason behind the overnight crash, “there emerges an overarching point.”

“It is not just about the U.K.’s free access to the single market and trade becoming costlier; investors are now perplexed by the country’s vision on immigration, openness and business’ friendliness,” he said.

“This will be detrimental to the outlook for sterling given the global status that the U.K. has enjoyed for so many years,” he added.

On Friday, HSBC reiterated its forecast for the pound to hit $1.20 by year-end, falling to $1.10 by the end for 2017 and forecast parity for the pound versus the euro. Kamal Sharma, director and G10 FX strategist at Bank of America Merrill Lynch, gave CNBC his “worst case scenario” for cable (another term for the GBPUSD currency pair) on Friday.

“We’ve always been of the view that ‘Article 50’ will be the dominant driver for sterling over the coming few months,” he told CNBC Friday. “And we’ve been very hard in emphasizing the fact that the risks are very much to the downside in our forecasts.”

“If we see the monthly declines continue in cable that we’ve seen since July, that would be about a 1.3 percent fall in cable per month, if you extend that out towards the end of 2017, that quite conveniently puts cable at 1.05 – that’s not a base case scenario but if the pace of that declines continue we could see those levels that we saw back in 1985,” he added.

Source: Reuters