LONDON  - Brexit is dragging Ireland out of Mario Draghi’s force field. The European Central Bank chief has all but promised to ease monetary policy. Yet yields on Irish 10-year sovereign debt are rising further away from their German and French equivalents and closer to those issued by the country’s nearest neighbour. Blame growing concerns that Britain will exit the European Union in a disorderly fashion.

Sterling has been the biggest casualty in financial markets of British Prime Minister Boris Johnson’s insistence that his country will leave the EU on Oct. 31 - “no matter what”, as his office said on Tuesday. The currency is down more than 2% against the U.S. dollar since the former mayor of London took charge last week. But what’s bad for Ireland’s biggest trading partner will also hurt for the Irish economy.

Ten-year Irish bonds were yielding as much as 0.22% on Tuesday, more than double July 5 levels. Even more telling, the yield gap between 10-year German and Irish debt widened to nearly 63 basis points. Moreover, UK 10-year sovereign debt now yields only 47 basis points more than the Irish equivalent; the gap was nearly 68 basis points as recently as July 2.

Given that the British economy would suffer the biggest impact of leaving the EU without a deal, it may seem odd that Irish bonds are feeling more pain than UK gilts. The problem is that, unlike its neighbour, Ireland has neither its own currency nor control over monetary policy.

UK bond prices have been buoyed by expectations that Bank of England Governor Mark Carney will cut interest rates and may even restart bond buying if there’s a “no deal” Brexit. But Draghi can’t tailor euro zone policy to suit Ireland.

That means Dublin will have to lean more on fiscal policy to absorb any economic shocks. Irish Finance Minister Paschal Donohoe said last month he would run a budget deficit of between 0.5% and 1.5% of GDP following a no-deal Brexit and that it would take three to four years for the government to return to a surplus. That would be a big shift for a country whose national debt is still around 100% of gross national income. The more such frailties Brexit exposes, the weaker the ECB’s gravitational force.

CONTEXT NEWS

- Irish government bond yields rose as high as 0.22% on July 30, up five basis points from the previous day’s lows and more than double the levels seen on July 5. The increase reflected growing concern about the potential impact on the Irish economy if Britain were to exit the European Union in a disorderly way.

- The yield gap between German and Irish bonds reached 62.8 basis points, its widest in two months, on July 30.

- Prime Minister Boris Johnson “made clear that the UK will be leaving the EU on October 31, no matter what," Johnson's office said in a statement following a phone call with Ireland’s prime minister, Leo Varadkar.

(Editing by Peter Thal Larsen and Karen Kwok. Graphic by Vincent Flasseur.)

© Reuters News 2019