It’s Brexit Politics, Not Economics, Threatening European Bonds

  • Nordea says Dutch, Italian, Finnish bonds vulnerable to vote
  • Irish opt to stay out of bond market to avoid U.K. risks

Who potentially loses if the pollsters and bookmakers are wrong on Brexit? Add bondholders from Finland to Italy to the list.

Brexit could fuel the rise of “extreme political movements” and tap into simmering resentment toward the European project, according to Jan Von Gerich, chief strategist at Nordea Bank AB in Helsinki. In Italy, the extra yield on 10-year government bonds compared with German equivalents was 120 basis points on Tuesday. It would rise above 175 basis points after a Brexit vote, analysts at UBS Group AG said.

Rather than the trade implications of Europe’s second-largest economy leaving the 28-member European Union, the concern is that a decision to exit the bloc in the U.K.’s June 23 referendum could spark a spate of similar votes across the region. Half the voters polled by Ipsos Mori in eight countries believe their own governments should hold votes on staying in the EU.

“Political consequences should worry bond investors much more than direct economic links,” said von Gerich. “In case Brexit happens, spreads towards Germany would likely widen across the board. Dutch, Italian and French bonds look vulnerable. In the semi-core space, there are no good alternatives.”

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So far, euro-region bond investors have been largely unmoved by Brexit. That’s because the European Central Bank’s quantitative-easing program stands behind the market and, in part, because the campaign to keep Britain in the EU seems on track to win. The latest polls show a 51 percent to 46 percent lead, while bookmaker William Hill Plc puts the chance of Brexit being rejected at 83 percent.

Hard Bargain?

Should they be wrong, the U.K.’s treatment following a Brexit could damp enthusiasm for similar votes, according to Jamie Murray, EMEA chief economist at Bloomberg Intelligence in London. The U.K. faces a two-year period of talks to decide on the terms of its exit.

“For Britain’s jiltees, there would be no incentive to be kind,” said Murray. “To limit the risk of an exodus, the European Commission would be likely to drive a hard bargain.”

Still, the head of Ireland’s office said on May 26 the country opted not to hold a bond auction in June to “protect” itself from volatility stemming from the referendum. Ireland’s biggest trading partner is the U.K., accounting for about 50 billion euros ($56 billion) of imports and exports.

The premium, or spread, of 10-year Irish bonds over bunds would widen above 90 basis points from 60 basis points in the event of Brexit, UBS analysts Nishay Patel and John Wraith wrote in a note to clients.

Contagion Risk

Resentment with the EU is already evident in spots across the region. The Dutch will hold elections next year, and the anti-Islam Freedom Party, which wants the nation to exit the EU, is on track to be the biggest party. In Italy, the euro-skeptic Five Star Movement is gaining ground. In Finland, Brexit would hurt an already “ailing” economy and stoke speculation around the nation’s place in the euro region, von Gerich said.

“Whether the U.K. votes to leave or not, there will be other referendums elsewhere, ” Michael O’Leary, chief executive officer of Ryanair Holdings Plc and a leading “remain” campaigner, told a forum in Dublin last month. “We shouldn’t underestimate the contagion effect of the U.K. leaving. It throws a question over the wider future of the EU. ”

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