Pound’s ‘flash crash’ strains bond, stock market nerves

Sterling lost as much as 10% of its value in just a few minutes of trading yesterday, a “flash crash” that fuelled concerns about the vulnerability of the currency and other British assets to investor worries about Brexit.The pound recovered from the initial plunge, which took it as low as $1.1491 in Asian hours and was driven, dealers said, by the automated algorithmic computer trades that now dominate the global foreign exchange market.But selling by European and US investors quashed any bounce as first London then New York came on line, driving a 2% loss on the day and putting sterling on course for its biggest weekly fall since 2009.That sounded like good news to investors in internationally focused UK firms, which gain on overseas revenues and competitiveness when the currency falls.The FTSE 100 index rose 1% while other European stock markets fell sharply.But there are growing worries about the impact sterling’s losses and the Brexit nerves behind them will have on domestic demand, inflation and economic growth in the years ahead.Ten-year gilt yields rose by as much as 11 basis points to 0.984%, the highest since the week of the referendum vote to leave the European Union in June.The FTSE 250 index of medium-sized UK firms, typically more dependent on the domestic market, fell for the third day running after hitting an all-time high on Tuesday.“We can dismiss what happened in Asia, but the bias for sterling’s performance remains downward,” said Neil Mellor, a currency strategist with Bank of New York Mellon in London.“The speech by (Prime Minister Theresa) May this week thrust the prospect of a “hard Brexit” upon the market.The fact is that the bias to the downside is going to remain there until we see some details from the negotiating table.” Sterling has been falling steadily for a fortnight, as investors fret that the government’s intention to prioritise immigration controls over access to the single market in exit talks will spark deeper cuts to foreign investment in Britain.So far, pension funds and other long-term fund investors have responded by buying UK shares and other assets while hedging the currency risk through options and other derivatives that allow them to sell the pound.That may change if the currency proves too volatile to allow them to fund those trades, and measures of implied market volatility surged on Friday to more than 10% for durations out to a year.Retailer Sports Direct said the overnight move in sterling, after it had entered into a hedging agreement to protect against weakness in the pound, led to a £15mn dent in its full-year earnings forecasts.“If the rate is $1.20 on average for the remainder of FY17, then the negative impact...would be in the order of a further £20mn,” it said.The pound also fell more than 2% to 90.23 pence per euro, its lowest in almost seven years after moves overnight that mirrored those against the dollar.Sterling-denominated gold rose to its highest since mid-July at 1,059.06 pounds an ounce overnight, despite a near 5% drop in spot gold prices this week.Foreign investors overall hold half of all UK stocks and around a third of gilts, totalling more than $2tn.The fear that the value of returns on those assets will be eroded steadily by inflation showed up in pricing of forward interest rate swap agreements, which rose to imply a rise in long-term inflation to 3.64%.Before yesterday’s events, forecasts for the bottom of the pound’s fall had generally been around $1.20-1.25, with the caveat that there is no technical support between there and all-time lows just above parity with the dollar.HSBC strategist David Bloom forecast a fall to $1.10 by the end of next year.“Sterling used to be a relatively simple currency that used to trade on cyclical events and data, but now it has become a political and structural currency,” he said.“This is a recipe for weakness given its twin (budget and current account) deficits. The currency is now the de facto official opposition to the government’s policies.”