GBP & Uncertainty Ahead of Scottish Referendum

Referendum and expected volatility
Referendum and expected volatility © forexop

On the 18th September, people in Scotland will vote in a referendum to decide if Scotland should remain as part of the United Kingdom, or go it alone as an independent nation.

A yes vote seemed unlikely just a week or two ago, but the latest Yougov poll show the Yes camp now has a thin majority at 51%. This has increased from 39% just one month ago –the odds of independence then seemed a remote possibility at 25% or less.

What Does It Mean for Sterling?

With the breakup of the United Kingdom now a real possibility, what does this mean for the UK Pound?

The high degree of uncertainty in the outcome of the referendum means we will most likely see increased volatility in GBP leading up to, and following the vote. There are still many open questions regarding a currency union between Scotland and the remainder of the UK, if indeed, there will be one, and if so exactly what form it will take.

A currency union is the favored choice of the SNP (Scottish National Party). However, the UK government has rejected the idea saying: “it is not in the UK’s interest to maintain a currency union with an independent Scotland”. The problem with this is that if the SNP does not achieve a favorable agreement on a shared currency, there is a real possibility that they will renege on their share of the public debt. This will leave the rest of the UK with a higher per capita public debt and a smaller economy to service it.

Rate Tightening

The greater impact could be on the Bank of England’s rate tightening cycle – which is widely anticipated to start early next year. A “Yes” vote could bring about enough uncertainty and distraction that the UK’s rate hikes will start later than expected.

Will sterling still be a relative safe-haven currency if Scotland breaks away from the union? Yes, probably. Scotland only contributes around 8% to the UK’s overall GDP. However, though small, Scotland is a positive contributor to the UK’s balance of trade – mostly due to North Sea Oil and Gas revenues. This will be a blow to the UK’s economy, but it’s unlikely to be a knock-out as it is balanced by the fact that public spending per capita is higher in Scotland than in the rest of the UK.

The Risks

Given that the economy would survive, questions remain about a divided UK and the distraction and uncertainty that a costly breakup would likely entail.

In the event of a “No” outcome, we could see a brief relief rally in Sterling. On the other hand, if the majority is thin, there will still be much uncertainty and probable risk factors. This could weigh down on the market until clarity is seen.

The first risk is the real possibility of political unrest – this was seen following the Quebec referendum which resulted in a slim “No” majority. The second risk is that given a slim majority in favour of staying in the Union, this will certainly result in greater devolution of powers to Scotland – the so-called devo-max or full fiscal autonomy. In a sense – compromised breakup, that could be messy and unpopular.

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