Since the UK voted itself out, the Brexit move has resulted in the drastic and unpredictable performance of its currency. The foreign exchange markets are about the most sensitive and liquid in the world and policy changes in a country may have a drastic impact on a country’s currency. According to Buttonwood, while currencies are expected to fluctuate depending on their demand levels, sudden negative changes in prices like those witnessed on the sterling indicate some underlying negative economic environment in a country.
On Friday the 7th, the value of the sterling fell by 6% from $1.26 to $1.8, a similar drop was witnessed with the euro, which is very unusual. This sharp change in the value of the sterling is only comparable to the sudden increase in the value of the Swiss Franc in 2015 after the abandonment of the Swiss National Bank’s cap. In fact, the sudden rise in the value of the Swiss Franc was because the country’s currency was highly demanded in the open market. On the contrary, the sterling is traded in the open market, and the UK does not use a fixed exchange regime to manipulate its value. Give that the drop in price has occurred after the country voted itself out of the EU market, this may be a sign that it is starting to experience negative results brought by this move.
Algorithmic trading is in part blamed for the sudden drop in the sterling’s price. Algorithmic programs have a trigger point that requires them to sell their assets, which are currency, securities, and bonds, once they fall beyond certain set point. A high sell-off rate of these assets is an indication of a decrease in their market demand. It follows that, if there is a decrease in demand for products, there is also decline in the product’s price. Therefore, the algorithmic programs behave almost like a perfectly competitive market by respond quickly to changes in the business environment. The quick sale of assets leads to a fall in prices, which trigger other programs to make a similar sale of the assets. The sales stop when the market price is low enough to trigger the programs to buy, which is the equilibrium price.
Inasmuch as the programs are blamed for the decline in the value of the sterling, the decision on whether to sell these shares is triggered by reports and information shared in the public. For instance, an increase in the deluge of reports and news mentioning “hard Brexit” may trigger the programs to sell. In reality, therefore, these programs simply respond to speculations by investors and the public on the economic and investment environment of a particular asset. A decline in the price of the sterling shows that there are negative speculations among investors on the viability of investing in the UK.
In particular, the hard-Brexit anti-immigrant and anti-business tone by the Conservative Party conference has changed the view of investors of the viability of their business in the UK. The political and business environment in the country is not good for companies. Investors are perplexed on the increase in the cost of trade to EU countries, access to EU single market, as well as the country’s openness and business-friendliness. While most investors have not yet relocated to other business-friendlier countries, these are early indications of possible such moves, which could significantly affect the country’s gross domestic product (GDP). In turn, these would affect the price of the sterling due to a reduction of exports from the UK.
Further, although a decline in the price of currency increases the demand for a country’s products, it is most effective where the currency is overvalued. In the case of the UK, the sterling is properly value. Therefore, a decline in its price will make UK citizens to pay more for imports and to earn less from their exports. Both of these results are negative to investors and may make them relocate their businesses to regions where they can make more profits. As a consequence, the sterling may have a steady decline in its value as investors move to cheaper and more profitable areas of doing business.
Buttonwood. Sterling Takes a Pounding. The Economist. (2015). Web. http://www.economist.com/blogs/buttonwood/2016/10/currencies