The RSM Brexit Stress Index increased to 0.71 standard deviations above neutral from 0.55 one week ago, amid continued uncertainty regarding timing of Britain’s departure from the European Union.
The factors pushing the index higher were primarily volatility across the foreign exchange markets linked to declines in the value of sterling. The FTSE 1000 declined on the week amid volatility in the government sector over the past several days.
Narrowing spreads in gilts and widening corporate bond spreads reflect risks in holding government paper and domestic corporate debentures due to the uncertain policy path of the administration of Prime Minister Theresa May over the timing, nature and magnitude of Britain’s potential exit from the EU bloc. Should the third attempt to pass the government’s exit plan fail, forward-looking policymakers and investors should expect stress in financial markets to increase sharply, creating risks of a spillover into the real economy that would further depress productivity-enhancing investment in the UK.
It is important to note that the stress associated with the daily change in the narrative coming out of the May administration on the exit cannot be decoupled from the growing stress in the European economy, the international economy and global financial markets.
During the week of March 18 it became clear that the notable deceleration of economic activity in both the United States and Germany reflects rising global recession risks over the next 12 months. German manufacturing sentiment eased to 44.7 in March, implying a significant contraction in the sector. The drop marks the third straight decline in the critical gauge that constitutes the heart of the European economy; it triggered a market response that drove down the yield on the 10-year German bund to zero.
In addition, the ten-year U.S. Treasury yield declined by 20 basis points to 2.41 from 2.61 percent during the final three days of the week following the end of the U.S. Federal Reserve’s policy normalization program and the downgrade of its growth and employment forecast. The U.S. 10-year less 3-month yield curve inverted this past Friday, implying that risk of a recession in the world’s largest economy is rising. Yields on the UK 10-year Gilt declined to 1.02 from 1.19 at the start of the week, reflecting growing global economic risks.
The combination of stress related to the path of policy on Brexit and increasing global headwinds faced by the British economy point toward a more difficult barrier to surmount for UK economic policymakers.
Ahead of the third attempt to pass the May administration’s Brexit plan, it is critical that the government begin considering policies to stimulate the domestic economy in general, as well as to generate private fixed business investment in the aftermath of whatever may come following the crucial vote in Parliament.