A few years ago the novelist Robert Harris published a book called The Fear Index, which graphically described how a supercomputer caused the financial crash to end all financial crashes, by betting against the markets and making its own financial decisions based on the data its algorithms picked up.
Just after midnight last Friday we saw something horrifyingly similar, when a “flash crash” caused the value of the pound to plummet from US$1.26 to $1.1491, an astonishing 8 per cent in a mere 240 seconds. At one stage it plunged as low as $1.13 in trading in Hong Kong and Singapore, and although it staged a recovery of sorts, hedge funds, investors and other speculators are now “shorting” sterling in volumes never seen before.
So far they have been doing remarkably well out of it. But they are not finished yet. According to market analysts, the hedgies are looking for more.
Sterling has now fallen by 14 per cent since late May, before the Brexit jitters set in, and by 19 per cent since the start of the year, which is actually more than Harold Wilson’s famous “pound in your pocket” devaluation back in 1967, which has haunted the Labour Party ever since. Wilson blamed “the gnomes of Zurich” for selling the pound, but now it’s the hedgies – or maybe the robots. A far more formidable enemy.
The Bank of England (BoE) has begun its own investigation into what happened in the Asian markets, and will probably find it was a combination of algorithms, hedgies, lack of liquidity and the fact that it was triggered during an Asian “graveyard shift”, when US and European traders were not at their desks over the weekend.
It doesn’t matter, because the damage is done and sterling, after a long period of stability, has become the hunted currency. To the chagrin of British officials, who have had great fun jeering at France and its poor economic record for the past few years, the British economy has now slipped to sixth from fifth place in the world. That is not good news for the new prime minister, Theresa May, as she sets out to prove that the British economy is big and vigorous enough to stand on its own feet and doesn’t need to be in the European single market.
The question now is – how much further can sterling fall? There are not many bulls of sterling around and this week it started off just about as nervously as last week. The pound was a little above $1.24 yesterday morning and a little below it in the afternoon.
Goldman Sachs’ forecast, made before the flash crash, is for sterling to sink to $1.20; Rabobank has now revised its forecast down to $1.18 by mid-2017; and HSBC is even gloomier, forecasting that the pound could go all the way down to $1.10 by the end of next year.
Other analysts are talking about something even below that. Over the weekend a number of forecasters mentioned the dreaded word “parity”, with the dollar, something we have not seen since 1985, when an inadvertent statement from Mrs Thatcher’s spokesman, Bernard Ingham, suggested that parity was government policy. It turned out that Ingham, who was very good at politics but hopeless at economics, had misunderstood his briefing and parity lasted only a matter of moments.
I think talk of parity is absurd. The British economy, for the moment at least, is still the best performing in Europe and has so far shrugged off the threat even of a “hard” Brexit, which is what we are now heading for. A weak pound is good for exports and British exporters have actually been responding. The BoE’s swift action to cut interest rates and supply liquidity has so far worked in keeping consumer spending up, and the services sector is doing its bit.
Nonetheless it will be a long, long time before sterling gets back to its pre-Brexit level, if it ever does. News from the IMF annual meeting in Washington last week was that Mrs May's message to the Conservative Party conference of a relatively hard Brexit went down badly. "You would be amazed how many policymakers and bankers were still of the opinion that Britain would not go through with it [leaving the EU]," wrote The Daily Telegraph financial columnist Jeremy Warner, who was at the meeting. "In markets, there are growing fears that the heart will be allowed to rule the head, leading to an irrational and economically harmful outcome."
Mrs May’s first serious economic remarks have sent all the wrong signals. The flash crash has shown just how dangerous that can be. Sterling has some rough times ahead before Brexit finally happens.
Ivan Fallon is a former business editor of The Sunday Times and the author of Black Horse Ride: The Inside Story of Lloyds and the Financial Crisis
Follow The National's Business section on Twitter