Market's vision of Brexit is too rosy

A painted Union Flag, popularly known as the Union Jack, the national flag of the United Kingdom is seen on the rocks on the English side of the River Wye, Chepstow, Wales, March 28, 2017. REUTERS/Rebecca Naden

LONDON (Reuters Breakingviews) - Divorce can be messy even, when both sides start out wanting an amicable settlement. Brexit may well work the same way now that Prime Minister Theresa May has triggered the process for Britain to leave the European Union. For now, investors are more hopeful than they were six months ago that the UK can quit the bloc without ravaging its economy, a Breakingviews index based on asset prices shows (

The Breakingviews index incorporates currency, bond, stock, and credit default swap prices. It falls when investors think a growth-damaging “hard Brexit” is more likely, and rises when they expect a more benign outcome. When the former occurs, sterling typically weakens and the domestically-focused FTSE 250 Index of mid-cap companies tends to underperform the FTSE 100 Index of blue-chips, which has a more international bias. Investors also tend to push up the cost of insuring against a British debt default relative to Germany, and compress the gap between two- and 10-year UK government bond yields.

As a result, the Breakingviews index fell sharply in the months after the June 2016 referendum in which Britons voted to leave the EU. It has since clawed back some ground, not least because growth has proved far more resilient than most investors and policymakers expected.

Yet the chances are that the gauge will fall in the months ahead. May wants to clamp down on immigration from other EU countries but so far been able to avoid tricky questions on what sort of trade restrictions others will want to impose as a result. The economic price that Britain may pay will become increasingly clear now that negotiations can finally start.

And even before any trade barriers are erected, growth could slow. Rising inflation is eroding the spending power of households. Meanwhile jobs and business investment may be more vulnerable if the negotiations start looking rancorous. Investors may be underestimating how closely political divorces can match real ones when it comes to bitterness and damage.


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