By Marc Jones
LONDON (Reuters) - Sterling tumbled and the rest of Europe's share markets groaned on Thursday after a long-awaited Brexit agreement was thrown into chaos as Britain's chief negotiator for the deal quit just hours after it had been unveiled.
Up until that point markets had looked relatively calm. Asia had cheered news that China and the United States were back in contact about their trade dispute, and oil was inching up again having halted a record losing streak.
But then came the hammer blow with Brexit minister Dominic Raab quitting in protest at Prime Minister Theresa May's deal for leaving the European Union.
"No democratic nation has ever signed up to be bound by such an extensive regime, imposed externally without any democratic control over the laws to be applied, nor the ability to decide to exit the arrangement," he said in his resignation letter.
Cue a sterling meltdown. The currency slumped a full 2 cents to $1.2750 and though that made the FTSE stronger -- a weaker pound makes life easier for exporters on the index -- big UK banks the rest of Europe sank swiftly into the red.
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"The reaction is sterling shows that the chance of no Brexit deal has spiked," said Tim Graf, Head of Macro Strategy for EMEA at State Street Global Markets.
"It also introduces thoughts of a leadership challenge (for British Prime Minister Theresa May) which seems likely now."
The turmoil also boosted demand for safe-haven German government bonds. Ten-year yields on what is regarded as one of the safest assets in the world, fell over three basis points to 0.36 percent -- its lowest in over two weeks.
UK government bonds saw a rush of demand too with the reflex dive for cover and the sight of state owned bank RBS stocks down almost 9 percent, drove the biggest fall in 5-year yields since just after the June 2016 Brexit vote.
EU leaders had said they would meet on Nov. 25 to endorse the divorce deal, but May now faces the much more perilous struggle of getting parliament to approve what was agreed.
"We are basically trading the headlines." said Ned Rumpeltin European Head of Currency Strategy at TD Securities in London. "I think a leadership challenge is imminent."
OIL SIMMERS
Investors were also starting to look ahead to U.S. trading where futures were pointing to a modestly higher start as forecast topping earnings from Walmart provided a welcome appetiser ahead of U.S. retail sales later.
In the commodity markets, where Brexit may be a sideshow but turbulence is still acute after a 12-day losing streak was set this week, the mood was much calmer.
U.S. oil futures steadied at $56.35 a barrel, after a slight bounce overnight. Brent was up 0.4 percent at $66.42.
MSCI's broadest index of Asia-Pacific shares outside Japan had also ended up 0.8 percent having fallen the previous day as the sharp slide in oil prices had heightened anxiety about the global growth outlook.
Shanghai Composite Index gained 0.9 percent, while Hong Kong's Hang Seng rose 0.8 percent on the China-U.S. communications, while Australian stocks inched up 0.05 percent and Japan's Nikkei shed 0.2 percent.
"While it's difficult to pin-point a specific event for the risk-off move, recent themes appear to be keeping markets cautious include oil's recent plummet, Apple's fall, U.S. political gridlock, China's slowing growth, tightening liquidity, a hawkish Fed, earnings peak, Italian jitters, and Brexit uncertainty," wrote economists at ANZ.
The S&P 500 had fallen for a fifth straight day overnight too, with financial stocks hit by fears of tighter regulations once the Democratic Party takes control of the House of Representatives.
U.S. equities have also been pressured by concerns that earnings growth might be peaking, trade tensions and a slowing global economy - factors that had triggered a rout in riskier assets in October.
"If U.S. stocks are to bounce back, economic indicators will be key," said Junichi Ishikawa, senior forex strategist at IG Securities in Tokyo.
"Focus will be on today's U.S. retail sales data, which will provide a view of how private consumption -the main component of economic growth- is faring." U.S. retail sales for October will be released at 1330 GMT.
(Reporting by Marc Jones; Editing by Toby Chopra and Angus MacSwan)