Declining British pound held hostage by prospects of a hard Brexit

The British pound’s sell-off on Friday was the second-worst since Britain voted to leave the European Union June 23. Justin Tallis / AFP

After a dramatically dismal week for the pound punctuated by a flash crash in Asia, traders doubt it will shake off its tag of the worst-performing major currency in 2016.

They’re negative because sterling is held hostage by the prospects of a hard Brexit and its impacts on the UK economy. That adds to concern over how the third-most traded currency pair, the pound-dollar, could crash and bounce back with no apparent explanation beyond speculation that computer-driven trading was to blame.

The pound’s weekly decline was the second-worst since Britain voted to leave the European Union June 23. The sell-off Friday, when investors were spooked by a 6.1 per cent plunge in two minutes, only hastened a decline that kicked off earlier in the week when prime minister Theresa May signalled a crackdown on immigration should take precedence over access to the bloc’s single market.

“There’s not a lot of upside” for sterling, said Ryan Myerberg, a portfolio manager at Janus Capital in London. “Extreme moves like the one we had overnight on Friday are obviously surprising, but there is a context of a country that is having a lot of political issues. We have a lot of uncertainty around what’s going to happen with Brexit and the relationship with Europe.”

Sterling slid 1.4 per cent to US$1.2441 on Friday as of 5:45pm in London. The weekly drop of 4.1 per cent, the most since June 24, brings its decline since the referendum to 16 per cent. The currency also depreciated against the single currency, down 3.5 per cent in the week to 89.72 pence per euro.

“The pound is still in the process of trying to establish a new equilibrium following the flash crash overnight,” which has “reinforced negative sentiment towards the currency” driven by concerns over a so-called hard Brexit, said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi. “It will take time after such destabilising price action.”

As strategists and investors speculated on what sparked the crash during Asian hours, the currency rebounded from a low of $1.1841, swinging more than six times as much as its one-year median move.

Signs that the divorce talks — and terms — of Britain’s planned exit from the world’s largest trading bloc were likely to be bitter emerged in the annual Conservative party conference that ended Wednesday. An aide to Brexit secretary David Davis outlined what he called red lines for the UK. They included giving up free movement of labour among others. In response, European leaders signalled a growing reluctance to grant any special terms to post-Brexit Britain.

“The pound is in a free-fall and nobody wants to touch it right now,” said Aurelija Augulyte, a strategist at Nordea Markets in Copenhagen. “But parity calls emerge, so the bottom must be near.” Augulyte predicts the pound will tumble to $1.20 and recover to $1.27 in three months.

As politics take centre stage for the currency’s future and with less than six months to go before the UK government has said it will trigger the EU’s Article 50 to begin its withdrawal, investors question whether the currency has found its bottom yet.

Friday’s flash crash-fuelled slump on the pound has made the possibility of a historic $1 level more real, with a Bloomberg forecasting model based on implied volatility showing about a 7 per cent chance of it happening within a year.

“The fact that you don’t get paid to own sterling, with rates at zero” and a “massive” current-account deficit are adding to the currency’s woes, says Mr Myerberg. He’s keeping his forecast for the pound at $1.20 by year-end, but with “potential to go lower.”

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