The Long March to Disunion: Britain, EU and the Markets

Summary

Since the U.K. voted to leave the European Union on June 23rd the Pound Sterling has lost 15.8 percent against the U.S. Dollar and 16.2 percent (10/6) versus the Euro. The FTSE 100 has, in the same interval, gained 21.1 percent. A strong economy normally enlivens the currency. Can Brexit be both good for the British economy, as the FTSE would seem to hold and bad for the Pound, the currency market view? The mediator could be British interest rates. The return on the 10-year Gilt has fallen almost 40 percent to 0.8840 (10/6) since the exit vote. But the credit market reaction is likely a reflection of Bank of England rate policy, anticipating a steady diet of monetary accommodation as negotiations with the EU commence, rather than a considered view of the long-term prospects for the British economy outside of the European Union.

The BOE cut its base rate 0.25 basis points in early August to 0.25 percent and the futures are predicting a long hold. The probability of an increase over the next two years, to September 2018, never rises higher than 34.7 percent. As the departure negotiations commence the risk of political intransigence can only gain, obscuring the long term economic interest for both sides to come to an agreement preserving the trade status quo.

Have the markets made a straightforward choice in basing their analysis on the policy response of the Bank of England rather than on any other more speculative economic or political scenarios? If the negotiations prove difficult how could market perceptions shift and to whose favor?

Join us as we untangle the skein of EU disunion.