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Would the market shock force Parliament's hand on Brexit?

LONDON (Reuters) – There's nothing like a market crash to focus politicians' thoughts and prime minister Theresa May could find…

LONDON (Reuters) – There’s nothing like a market crash to focus politicians’ thoughts and prime minister Theresa May could find that just a fool in British asset prices can convince a split parliament to retake its Brexit deal.

PHILPHOTO: British and EU flags are seen before the British Prime Minister Theresa May meets the Commission President Jean-Claude Juncker to discuss draft Brexit agreements at the EC headquarters in Brussels, Belgium, 21

November 2018. REUTERS / Yves Herman / File Photo

But how much do investors think that sterling and stock would need to think before legislators decide that a “no agreement” trip from the European Union must be deported?

Expectations that Parliament will reject the withdrawal agreement that May has negotiated with the EU has led investors to buy protection against a severe fall and implicit market volatility measures are up.

So far, however, there is no sign of the type of financial market carnage that can swing both pro and anti-British parliamentarians behind the maize agreement for fear that Britain could close out of the block on March 29 without any transitional arrangements.

It suggests that investors still see some form of negotiated exit as the most likely outcome.

The Bank of England has warned that a “no deal” scenario would be an economic shock similar to the oil crisis from the 1970s.

“What could focus on the minds of politicians would require you to see a significant fall (in asset prices) – more than we saw last week,” says Robin Marshall, a director of the interest-bearing securities company Smith & Williamson.

He estimated a fast move of between 5 and 7 percent in sterling and the stock market would lead to a reaction.

Parliament is likely to vote for maize agreement in mid December. If the counterparty opposes its plans, the risk is real that Brexit will be “no deal” by default.

It may spark what former consultant Rupert Harrison, now a BlackRock portfolio manager, has called the “TARP” model: the resulting market crash would see that legislators quickly abandon resistance to maize agreement and approve it in the second attempt with minor changes.

For a Graphics on Market Muscles and Tarp, Se – Tmsnrtrsrs / 2R5Djd8

TARP is a reference to the Troubled Asset Relief Program, a US government initiative to rescue banks in the height of the 2008 financial crisis. The rejection of TARP by the House of Representatives September 29 triggered an almost 10 percent fall on Wall Street. The house was backtracked four days later.

Other such parallels are superfluous. Greece’s Prime Minister Alexis Tsipras, was chosen in 2015 to reverse the EU-imposed tightening, pulled back on the campaign ceilings as tumbling markets threatening Greek banks.

In May, the largest Italian bond sales in 25 forced two bickering political parties to the table to form a coalition government, with politicians encrypting to confirm Rome’s commitment to the euro.

For a Graphics on Market Muscles and Italy, SE – T.nr.rs/2R3YbBn

“NOT SHOCKING EVER”

Closer to home there was “Black Wednesday”, the day 1992 when Britain was expelled from the European Exchange Rate Mechanism (ERM ) – a pioneer of the euro – after it could no longer defend the pound against speculative attacks. The crisis forced the authorities into a brutal cycle of interest rate hikes.

“Hard” Brexit can cause a similar economic disaster. UBS estimates that Britain would lose 10 percent of production, which is only slightly better with a “soft” deal, at 6 percent.

But it will be sterling that will be at the center if the TARP model is to save May – her game plan according to some, although others see it as wishful thinking. They argue that market changes have already been seen since June 2016, the referendum has done little to change the legislator’s view of Brexit and what form it should take.

“My opinion is that sterling needs to be under pressure to become a party to the chaos,” said Salman Ahmed, chief investment strategy at Lombard Odier.

Ahmed estimates that in a non-breakdown scenario the pound would slide an additional 10-12 percent. It would leave sterling close to $ 1.13, the lowest for more than 30 years.

“In Greece, for example, the pain in the market, especially in the banking sector, contributed to the compromise of Alexis Tsipras. I do not see it happening just in Britain because it was not shocking enough, he says.

Observers note the recent sterling has been limited despite the fact that they are acting dramatically. When the EU rejected May’s Checkers proposal for post-Brexit band on September 21, sterling fell 1.7 percent. It slipped another 2 percent on November 15 when ministers ended May Purchased Agreements.

This is compared with a 7.8 percent decline against the dollar on June 24, 2016 the day after the Brexit referendum.

Growing expectations that Parliament will reject maize agreement may undermine the TARP scenario as a first breakthrough for the bill is priced at markets.

For a graphic on Recent sterling, little falls towards Brexit’s voice aftermath, see – tmsnr.rs/2R5kMhb

Relatively intrinsic movements so far, investor confidence reflects that a smooth retirement or even a second referendum is more likely than a messy without agreement. It has made them careful to sell sterling directly, and fearing a major recovery in the undervalued currency if an exit agreement is reached.

Instead, they have seized derivatives rather than placing foreign exchange markets to take positions.

There are signs that if things begin to get very painful, other asset classes will feel it too.

Last week, when it appeared that the ministers mobilized to unseat May, FTSE’s inverse correlation with Sterling disappeared – a rare occurrence of the currency and British shares fall in tandem.

It also offered a glimpse of the broader economic chaos. Real estate shares fell sharply, which raised the fear of the housing market, the store of most of Britain’s wealth, to make a hit. Bank shares also tumbled and resumed the memories of Northern Rock’s collapse in 2007.

For a graphical image of correlations FTSE sterling 22 November, se – tmsnr.rs/2R3YgoF

“STRENGERS KINDNESS”

Most investors are reluctant to Choose a certain level that would convince politicians to agree on an agreement. But a rush in alternative markets to protect against additional sterling lips shows nervousness growing.

Strategist Simon Derrick, BNY Mellon, expects measures when marketing promotion is spread all over the world at a time when the liquidity is thin as the year-end to vacation.

“It’s when volatility begins to jump on international markets,” he said, pointing to the December-January period when, after a failed first attempt to get it through parliament, the government would have a short window to try again.

A pound in the pound presents risks because Britain’s major current account deficit does – in the words of Bank of England Governor Mark Carneys – dependent on “friendliness of strangers” or foreign investment to pay their bills.

Slideshow (3 Images)

The sterling devaluation since the 2016 referendum has reduced the deficit but still stands at 3.9 percent of GDP.

Ben Lord, a British fund manager at M & G Investments, noted that this resembled levels seen during the ERM crisis or Britain’s 1976 rescue operation of the International Monetary Fund.

“We do not want a catalyst where we see the strangers, the foreign money sources stop financing us. That’s when we get a very sharp sterling devaluation.”

Further reporting by Sujata Rao, Saikat Chatterjee and Abhinav Ramnarayan; Graphics by Ritvik Carvalho; Write by Tommy Wilkes; Editing Catherine Evans

Our Standards: Thomson Reuters Trust Principles.

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