Computer algorithms to blame for British pound plunge

The British pound dropped suddenly on Friday (File)
The British pound dropped suddenly on Friday (File)

The role of high speed computer trading is in the spotlight after the British pound plunged against other currencies like the New Zealand dollar.

Late on Friday morning the pound fell 6 percent in two minutes. The British currency fell to a fresh 31-year low against the US dollar.

It was sharply down against the New Zealand dollar as well, with the kiwi rising from just over 56 pence to around 58 pence.

The pound then regained much of the lost ground. But not all of it.

The New Zealand dollar was trading at 57.66 pence early on Monday morning, the highest it has been against the pound since November 1976.

Initially the suspicion was that the slump might have been caused by a "fat fingered trade". That is when someone accidentally types in the wrong sell order.

They might have been prompted to sell by an article that was published in the Financial Times that said France was going to play hardball on the conditions for the UK to leave the European Union.

Computer algorithms then added to the selling pressure. Once one large order goes through other computers start selling, triggering even more selling.

Many hedge funds and other large traders program their computers to automatically start trading when prices reach certain levels. Computers account for 95 percent of the world's currency trades.

Because the US and UK markets were closed there was not as much trading going on. It is what is known as a lack of liquidity. That meant the initial selling that occurred had an even bigger effect than it might otherwise have had.

There have been an increasing number of sharp selloffs in the currency movements.

The Swiss franc fell by forty percent in a few minutes in January 2015.

The New Zealand dollar was sold-off heavily in August 2015, before recovering just as quickly. It fell to 62.44 US cents in overnight trading, before bouncing back to 64.90 US cents by 8am. The slump occurred while most New Zealand investors were asleep, and the lack of liquidity would have exacerbated the move.

Some people quickly discounted the "fat finger" theory as the cause of the selloff in the pound, focusing instead on the algorithms.

They say that some of the trading computers are programmed to search news sites and social media for negative headlines. The computers presumably seized on the Financial Times headline and began trading.

But even if it was not a fat finger trade human error might still have been a factor. Some analysts say someone must have made a mistake when they programmed the computer that initiated the sell-off.

The Bank of England is investigating what happened.

Regardless of what caused the sell-off the pound looks like staying weak for some time. It was already under pressure last week after British Prime Minister Theresa May announced she was setting a timetable for Britain to leave the European Union.

She will trigger 'Article 50' by the end of March next year, beginning a two year negotiating period between Britain and the EU.

The markets were alarmed by Theresa May's comment that curbing immigration would be a priority for her government. That raised the prospect that the UK could leave the EU's single economic market altogether.

The kiwi was sitting at 57.55 pence at 7am Monday. The dollar has not been near these levels in 40 years.

Back in November 1976 the Kiwi traded in a range between 57.98 and 59.74 pence. Reserve Bank figures going back to 1973 show that the New Zealand dollar reached 62.85 pence on January 17, 1974.

The New Zealand dollar was trading at 71.56 US cents.

It was 94.38 Australian cents, 73.69 Japanese yen and 63.89 Euro cents.

Newshub.

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