Europe Markets: Europe’s key stock index takes cautious step higher with Brexit ‘moment of truth in focus’

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Europe’s main equity benchmark rose tepidly on Wednesday, extending a rally in the pervious session that marked the best day since early April, but hand-wringing around faltering negotiations between the European Union and the U.K. over a trade deal to exit from the trade bloc continued.

What are markets doing?

The pan-European Stoxx Europe 600 SXXP, -0.07%  gained less than 0.1% to 365.07, a day after notching its best daily climb since April 5, according to FactSet data. Meanwhile, the U.K.’s FTSE 100 UKX, +0.20% rose 0.3% to 7,077.50.

Germany’s DAX 30 DAX, -0.33%  slipped 0.3% to 11,742.42, while France’s CAC 40 PX1, +0.05%  advanced by 0.2% to reach 5,185.57, following its best day since early April.

Italy’s FTSE MIB Italy index I945, -0.22%  was trading flat at 19,723.21, after registering its best daily gain since Sept. 10 when the index jumped 2.3%.

The euro EURUSD, -0.1123%  was off at $1.1566, compared with $1.1577 late Tuesday in New York. The pound GBPUSD, -0.3110%  was last changing hands at $1.3145, down from $1.3185 late Tuesday.

What is driving the market?

European investors are mostly focused on U.K. Prime Minister Theresa May’s “moment of truth,” as European Council President Donald Tusk has described a meeting in Brussels later today to try to break an impasse in Britain’s talks to extricate itself from the EU with a trade agreement in hand.

A so-called no-deal scenario is looking increasingly likely after Tusk on Tuesday said he harbored “no grounds for optimism” which could roil eurozone markets and produce sharp swings in the British pound.

The biggest snag in EU-U.K. discussions may center on the issue of trade between the Republic of Ireland and the U.K.’s Northern Ireland. The U.K. is slated to leave the EU on March 29 and talks are expected to be completed by mid-November.

Separately, a reading of U.K. inflation showed an annual rise of 2.4% last month, the Office for National Statistics said, a lower rate than the 2.7% recorded a month earlier and the 2.5% predicted by economists polled by The Wall Street Journal. However, wage growth hit 3.1% in the three months through August, and wholesale prices. In all, the readings seemed unlikely to hamper the Bank of England from lifting rates at least two more times over the next two years.

European investors also are following developments in Italy’s government, which Monday drafted a budget law for next year, confirming a set of measures that could lead to a fast-rising deficit but heightens a conflict with the European Union over the size and scope of its budget deficit.

The antiestablishment 5 Star Movement and the far-right League have rattled financial markets over the potential for a clash between Italy’s government and the EU, which could prove disruptive to the integrity of the bloc.

The full draft budget law will be sent to the Italian parliament by Saturday. Lawmakers will need to approve it by the end of the year.

What are strategists saying?

“Over the next few days investors will be keeping a very close eye on the EU summit which could provide some direction on Brexit. With a deadlock on the Northern Irish border issue seen as a major obstacle in Brexit talks, there is little hope for a breakthrough at the EU summit,” wrote Lukman Otunuga, research analyst at FXTM, in a Wednesday note.

“If the summit concludes with no real progress made on [negotiations], this simply raises the risk of a no-deal Brexit outcome. Given the pound is extremely sensitive to Brexit headlines, such a scenario could send the currency collapsing like a house of cards,” he concluded.

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