Brexit joke on market
1st April and the UK remains part of the EU. I guess the joke is on us. However, the sterling is no longer getting the “kick the can” bounce. Prior to last week, GBP had benefited from delays as the perception was that the longer Brexit was postponed the higher likelihood of an “ultra-soft” or even No-Brexit result. Yet following the third defeat of the Prime Minister May’s Withdrawal Agreement the GBP reaction was negative. Despite growing narrative (supported by wide protests), none of the eight options offered to PMs reached a majority. While permanent custom union and 2nd referendum got the closest, the hidden vote to reject Brexit did not appear. Our view is that should a vote go to the people it’s unlikely that Brexit will reverse. Today, MPs will get another vote, where the outlook for a consensus on a permanent custom union has improved. Yet the conservative party and cabinet remain divided and May is likely to call a new election rather face down a rebellion. Political chaos will not have a clear negative effect on sterling as the UK marches toward 12th April deadline. The choice between hard Brexit and present agreement is difficult. Least ugly contests generally increase the likelihood for a random event to blow apart any smooth forecast (baseline May Withdrawal Agreement will get the votes). With a limited event calendar, RBA and inflation reads will dominate it seem we are stuck watching the UK politics.
Italy under water as ongoing crisis weighs on the economy
The Italian crisis saga is not over. The economy has consistently grown at a slower pace than the euro zone due to structural inefficiencies while heavy pressures induced by the European Commission with regard to the budget deficit target is expected to resume in 2H 2019. Yet a break-up of the ruling anti-establishment 5-Star Movement and right-wing League following European elections starting in 23 May 2019 would be seen as a positive headline as most polls favor a centre-right majority.
Despite a major slowdown of the Eurozone globally, it appears that Italy remains one of the most exposed country within the single market. The debt is second-highest after Greece, with a debt equal to 132.10% of GDP, while a risk of rating downgrade would put additional pressure on already vulnerable Italian banks. Indeed, Italian government bonds heavy reliance on domestic demand and more specifically Italian banks (along 10%) poses further worries. The potential overshoot of the 2.04% of GDP deficit target (estimated above 3%) could not only prompt up sanctions from Brussels but also trigger a wave of rating downgrades, which should ultimately weigh on Italian banks whose reliance on Italian state creditworthiness is at its peak. Overall, the Italian economy is expected to show a slight recession in 1Q 2019 while a rebound in the automotive industry and exports to China as well as ECB monetary policy should provide short-term support for Q2. However, impending confrontation with Brussels as well as autumn rating agency credit assessment should weigh on the economy in 2H 2019.
Currently trading at 1.1245, EUR/USD is heading along 1.1256 short-term.
