Sterling plunged by as much as 6 per cent against the dollar overnight in a “flash crash” during the Asian trading session.
The pound fell as low as $1.18 in a matter of minutes, hitting fresh 31-year lows before recovering to $1.24.
Market-watchers pointed to comments by French president Francois Hollande, who insisted the European Union must take a tough stance in negotiating Brexit, and a “rogue algorithm”. The Bank of England said it was “looking into the cause of the sharp fall”.
Algorithmic trading, sometimes referred to as algo-trading, involves programming computers to follow a set pattern of instructions when placing trades at lightning fast speeds, quicker than any human trader could. Their use aims to maximise profits at the fastest possible pace.
Kathleen Brooks, research director at spreadbetter City Index, said: “Apparently it was a rogue algorithm that triggered the sell-off after it picked up comments made by the French president, Francois Hollande, who said if Theresa May and co want hard Brexit, they will get hard Brexit.”
Brooks added: “These days some algos trade on the back of news sites, and even what is trending on social media sites such as Twitter, so a deluge of negative Brexit headlines could have led to an algo taking that as a major sell signal for GBP.
“Once the pound started moving lower, then more technical algos could have followed suit, compounding the short, sharp, selling pressure.”
Traders have been increasingly alarmed since the Conservative Party conference began last weekend, with the Prime Minister giving her clearest indication yet that Britain is hurtling towards a so-called “hard Brexit”.
It would involve pulling Britain out of the European single market so the UK government can tighten its grip on immigration.
Mike van Dulken, head of research at Accendo Markets, said: “Last night’s sterling slump was the second most extreme on record versus the dollar and the worst since the panic of 24 June when markets reacted to the UK’s referendum result on EU membership.
“Investigations are underway but a single reason may never be identified for last night’s flash crash on the pound.”