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Oct 16 (Reuters) - Sterling, shares in British banks and
even German and Irish government bonds are among the financial
assets most sensitive to Brexit developments as long-running
negotiations on Britain's departure from the European Union
enter a crucial week.
The pound surged as much as 1.5% on Tuesday to a near
five-month high of $1.28 after Bloomberg reported British and EU
negotiators were close to a Brexit draft deal.
It gave up a large chunk of those gains on Wednesday as
expectations of a last-minute agreement moderated.
The British currency enjoyed its best week since 2017 last
week after Prime Minister Boris Johnson and Irish counterpart
Leo Varadkar said they could see "a pathway" for an agreement
for Britain to leave the EU by Oct. 31.
The two sides must clinch a deal before or during an EU
summit on Oct. 17-18, which must then be approved by the British
parliament.
While Brexit has cast a cloud over world markets since the
June 2016 referendum resulted in a narrow win for Leave, some
assets are particularly sensitive to headlines and will show an
outsized reaction, whatever the outcome of the talks.
Following is a graphical tour of just what's in play as the
Brexit endgame plays out:
SILVER AND GILT
Sterling's exchange rate has been by far the most sensitive
price to Brexit news flow. Last week, optimism a deal can be
reached drove the biggest two-day pound rise in over 10 years
. A negotiated deal will likely send the pound into the
"low 1.30s" against the U.S. dollar, JPMorgan says. UBS Wealth
Management expects a rise to $1.35. Reuters polls
foresee sterling between $1.27-$1.34 if a hard Brexit is avoided
but a "worst case" outcome of no-deal will see it between $1.10
and $1.19, the poll showed.
Two respondents predicted parity with the dollar.
Recent sterling gains rippled into derivatives markets, with
one-month risk reversals -- a ratio of bullish to
bearish bets on sterling -- flipping into positive territory for
the first time this year and indicating a washout of negative
bets. It has been positive only three times since the 2016 vote.
A sterling move up would also up-end excessive 'short'
sterling bets on futures; Reuters calculations show net short
bets for the pound are still nearly double their historical
five-year average.
HOME AND ABROAD
Some of the biggest winners from a Brexit deal will be
shares in companies that earn their living from the UK economy.
Unloved for years, an index of such shares soared on Friday,
rising more than the blue-chip FTSE benchmark for the first time
since May.
The index, compiled by JPMorgan and tracking about 30 stocks
that make all or most of their revenue in the UK,
soared almost 8% for its best day since the grouping was created
nearly three years ago. House builders such as Persimmon
and Barrett, as well as domestic banks Lloyds
and Royal Bank of Scotland, drove the rally.
Since May, the index has languished at a discount to the
FTSE-100 as fears grew of a disorderly EU exit that would
inflict huge damage on the British economy. The markdown widened
after Johnson took over as prime minister.
On Friday, though, the index outshone the internationally
focused FTSE 100 by 4.4%. To put Friday's moves into
context, RBS's 11% surge was its biggest move in either
direction since June 24, 2016, the day after the referendum.
MONEY MARKETS
A no-deal outcome would likely force the Bank of England to
cut interest rates to shore up the economy but last week's
optimism washed out money market bets on a rate cut in March. No
cuts are now expected until December and a Brexit deal may
dampen that possibility too.
An orderly Brexit would also reduce pressure on the European
Central Bank to cut interest rates and might also boost the
euro. Money market futures have trimmed chances of an ECB cut in
December to 20% from 40% early last week.
BOND BULLS TAMED - OR NOT
Brexit clarity would go a long way to removing some of the
entrenched pessimism that has swept a whole swathe of the euro
zone government bond market into negative yield territory.
Brexit jitters have not only boosted demand for safe-haven
German or U.S. debt but also fuelled economic growth worries in
the bloc -- the UK is Germany's fifth largest export
destination.
No wonder then that bond yields in Germany -- viewed as a
proxy for the euro area -- have tracked sterling closely in
recent months. Goldman Sachs predicts a near-term Brexit
resolution could send British bond yields at least
20 basis points higher and push up German and U.S. Treasury
yields by 10 bps and 5 bps respectively.
JPMorgan told clients its 'overweight' in euro zone debt
would benefit from any Sino-U.S. trade deal as well as from a
Brexit agreement.
WILL IRISH EYES BE SMILING?
No euro zone country has a higher stake in Brexit than
Ireland. Not only is Britain Ireland's largest trading partner
but its border with the British province of Northern Ireland has
been the thorniest issue in Brexit negotiations. A disorderly
Brexit risks a return to the violence that plagued Northern
Ireland for decades before a 1998 peace deal.
"One of the things you can observe is that when risks of
no-deal Brexit rise, Ireland tends to underperform," said Peter
Schaffrik, global macro strategist at RBC Capital Markets.
The Irish government has pledged 1.2 billion euros to
alleviate the effects of a no-deal Brexit, allowing its budget
to go into deficit. No wonder then that Friday's positive Brexit
noises pushed its 10-year government bond yields 10 bps lower.
Its spread over Germany -- effectively the yield premium
investors demand to hold Irish debt -- is at 144 bps, the
tightest since late July.
Irish stocks likewise jumped 4% on Friday with bank shares
rising as much as 11%.
EASTERN EXPOSURE
Brexit will reverberate in eastern Europe too. With 900,000
nationals living in the UK, Poles are Britain's biggest
immigrant group, sending home a billion euros a year in
remittances. Britain is also Poland's second-biggest export
market -- Warsaw runs an annual trade surplus with the UK of
just over 8 billion euros.
No wonder the zloty plunged as much as 4.7% against the euro
and 9 per cent against the dollar on the day after the
referendum.
Hungary and the Czech Republic are exposed to British demand
for vehicles, with 0.2% and 0.35 of their respective GDP linked
to 'value added' exports to the UK, ING Bank calculated late
last year.
The longer-term threat is what Brexit means for the 2021-27
EU budget. Britain contributes around 6 percent of the budget
and its departure will see average EU GDP per capita levels
decline. That will push incomes in Poland, the Czech Republic
and Hungary above the EU average and may spell cuts to their
funding.
(Reporting by Saikat Chatterjee, Dhara Ranasinghe, Josephine
Mason, Marc Jones and Thyagaraju Adinarayan; Compiled by Sujata
Rao; Editing by Catherine Evans)
