Sterling falls below $1.20, hitting its lowest level since October 2016 flash crash

Key Points
  • At around 8:00 a.m. London time on Tuesday, sterling was trading as low as $1.1968, its lowest since a flash crash in October 2016.
  • U.K. lawmakers return from summer recess on Tuesday afternoon, with a cross-party group of lawmakers expected to begin the first of a range of measures intended to block the possibility of a no-deal Brexit on October 31.
British Prime Minister Boris Johnson delivers a speech at 10 Downing Street on September 2, 2019 in London, England.
Chris J Ratcliffe | Getty Images

Sterling fell below $1.20 on Tuesday morning, reaching levels not seen since October 2016 as Britain's constitutional crisis over Brexit threatens to come to a head.

At around 8:00 a.m. on Tuesday, sterling was trading as low as $1.1968, its lowest since a "flash crash" in October 2016. The brief crash saw the pound fall 6% in a matter of minutes during Asian trading hours to $1.1491, confounding market participants.

While no single factor caused the sudden nosedive in late 2016, an official report from the Bank for International Settlements concluded that it was caused by a combination of headline-sensitive algorithmic trading, inexperienced traders and a lack of active market participants given the time of day.

Brexit showdown

U.K. lawmakers return from summer recess on Tuesday afternoon, with a cross-party group of lawmakers expected to apply for an emergency debate and seize control of the agenda of the House of Commons, in a first effort to stop a no-deal Brexit.

No-deal Brexit is becoming more likely, expert says
No-deal Brexit is becoming more likely, expert says

This would be subject to a vote, which if passed, would tie Prime Minister Boris Johnson's hands ahead of the suspension of parliament from September 9 until October 14.

Johnson has vowed to leave the European Union on October 31 with or without a deal in place, and reiterated this pledge in a speech Monday evening. He also insisted that the chances of striking a new withdrawal agreement have increased.

However, government officials have said that if parliament votes in favor of the opposition's amendment to the terms of emergency debate in order to allow it to go ahead, the prime minister will call a snap general election for October 14.

In order for the vote to pass, a number of rebel lawmakers from within Johnson's ruling Conservative Party must flout his orders and join forces with the opposition, with several indicating already that they plan to do so. The prime minister has this week threatened to expel Conservative lawmakers who vote against him.

A "no-deal" Brexit is widely seen as a "cliff-edge" scenario to be avoided at all costs, resulting in Britain leaving the bloc with no transition period for legal and trading arrangements. Such an event is expected to cause food and medicine shortages along with significant border and travel disruption, according to the government's own contingency plans.

A 'lose-lose' scenario

Stephen Gallo, European head of foreign exchange strategy at BMO Capital Markets, told CNBC via email Tuesday that the British currency is "cornered on the downside."

"On the one hand you have the global and euro zone growth backdrops, which are both acting as a drag on the currency. On the other hand, it seems highly likely that we will land on some sort of permutation involving a WTO Brexit, early elections or both," Gallo said.

Rebel lawmakers launch bid to stop a no-deal Brexit
Rebel lawmakers launch bid to stop a no-deal Brexit

BMO strategists have outlined two possible scenarios for Brexit. In the first, the anti no-deal faction pushes legislation through forcing the government to request an extension of Article 50, the legal mechanism which triggered the U.K.'s departure process.

The government then refuses to request an extension, instead engineering a no-confidence motion in itself or leading the opposition parties to launch one. The government loses the no-confidence vote, announces new elections between mid-October and mid-November, and in the meantime, the U.K. exits the EU on World Trade Organization (WTO) terms without a withdrawal agreement on October 31.

The second scenario follows the same sequence of events but the government wins the confidence of the House of Commons, or the House refuses to vote in favor of early elections but the government still resigns.

"In that case, the opposition would probably seek to form a government and craft a new legislative agenda (i.e. new Queens Speech)," Gallo projected.

"This would need to be voted on by the Commons over the coming weeks, and it would probably fail to pass the House. In that case, it would probably be quite likely for the sovereign to formally dissolve parliament and implement an election date by statute."

He concluded that this bind means GBP faces a "lose-lose scenario" until after Brexit is resolved, or the result of the election is known.

Correction: This story has been updated to show that sterling was trading as low as $1.1968 at around 8:00 a.m. London time on Tuesday.