What is the Scottish Referendum? Scotland has been a part of the UK for over 300 years. Last year, Scotland reached an agreement with the UK to hold a referendum on Scottish independence. The Scotland National Party has an outright majority in the Scottish parliament and a referendum has been a longstanding pledge.
When will the referendum be held? The referendum is scheduled for September 18. The phrasing of the question is straight forward: “Should Scotland be an independent country?” There is no threshold of turnover that is required, and a simple majority will carry the day. Residents of Scotland, sixteen and older can vote. Other dates to note include, May 5, 2015, UK national elections, March 24, 2106 Scotland Independence Day if “yes” vote wins, and May 5, 2016 Scotland election.
Why the sudden interest? Polls have consistently shown the “no” camp with a lead. However, this past weekend, a YouGov poll put the “yes” camp ahead 51% to 49%. This represented a 4 percentage point pick up for the “yes” camp over the past week. This excludes the undecided. If the undecided are included, the YouGov poll would show the “no” camp still ahead 47%-45%. Another poll out over the weekend (Panelbase) still had the “no” vote ahead. Statistically speaking, it is simply too close to call.
How is the UK government responding? The UK seemed to have three reactions. First, it did not seem to take the Scottish Nationalists intentions seriously. Second, when they began to do so, they appeared to resort to what were perceived as scare tactics, playing up the economic cost of independence, and indicating it would not have a currency union with an independent Scotland. All the major parities were in consensus about this. Third, the main parties are expected to announce new devolution measures that would give Scotland greater authority over taxes, spending and welfare. The heads of the three main parties will campaign for the “no” vote in Scotland.
What are the implications of an independent Scotland? Scottish economy is deeply integrated into the rest of the UK economy. Around 2/3 of Scotland’s exports go to the UK. And Scotland would be the destination about 40% of the UK exports to the EU. Banks headquartered in Scotland (RBS and Lloyds) were aided by the UK government. There are also extensive fiscal transfers from the rest of the UK to Scotland. The head of the Scottish National Party has threatened to repudiate Scotland’s share of the UK debt. In any event, a vote for independence will be followed by an 18-month period of negotiations and preparation during which these issues would be addressed. It appears that the most likely scenario would be for the UK to continue to service its debt, and a negotiate a repayment schedule for an independent Scotland.
What currency would an independent Scotland use? It is not immediately clear. The economic integration suggests some form of sterlingization is best, but that limits the degrees of freedom for a new independent country. However, UK officials have ruled out a formal currency union. That would not prevent Scotland from establishing a currency board or a formal peg to the sterling. A purely independent floating Scottish currency risks significant economic disruption.
Are there any particular sectors that are more vulnerable than others? UK banks were under pressure following the YouGov poll as one might expect. In addition, there is concern about the North Sea oil fields were Scotland has claims. This may impact international oil companies such as Chevron and Total who have operations in what could be contested waters.
Why did the British pound sell-off so hard in reaction to the YouGov poll? The market was trading more on uncertainty than certainty. Until this past weekend, the Scottish referendum was not a major market factor as few took seriously the risk of a “yes” vote. As of September 2, the gross long sterling position in the futures market stood at 67, 500 contracts, which represents about a 33% reduction since the multi-year peak was recorded in mid-June. This is more than the gross long euro and yen position combined. The net (gross longs minus gross shorts) stood at 9,400 contracts, while the net speculative position in euros, yen, and Swiss francs was short.
What are the implications for the UK if Scotland was independent? Part of the impact will depend on if Scotland repudiates its share of UK debt. If so, it would raise the UK’s debt-to-GDP because GDP would shrink by 8-9% and there would not be a corresponding reduction of the debt burden. It would rise from about 77% of GDP yo about 86%, according to projections. Repudiation of the debt by an independent Scotland would not put the new country in good stead in the eyes of the international investor community, but the extent of the fallout is debatable, and may depend the larger context.
What about the broader implications for the UK? The market suspects that an independent Scotland would be such a shock that it would postpone the beginning of the Bank of England’s tightening cycle. Many had appeared to shift expectations to Q1 2015, where we have been consistently anticipated. Some suspect a “yes” vote would also trigger a political crisis in the UK and could lead to a fall of the Tory-led government. However, at the same time, the Scotland is a large Labour bulwark, and its exit could shift the UK to the right politically. This would heighten the risk that the UK votes to leave the EU. Prime Minister Cameron is already facing a rebellion of sorts by backbencher and the UKIP is also appears to the rise.
What is the outlook for sterling?
We have suggested that the $1.60 area for sterling, which houses the 200-week moving average and is a key retracement objective as a reasonable target before the referendum. A “yes” vote would likely spur additional losses. Technical considerations give sterling potential toward $1.5725 as the next target. If the gap created by the September 8 sharply lower opening is a measuring gap (that takes place around halfway through a move), it would project toward $1.5100.
See Scottish Referendum 100 Days and Counting for additional background.
This piece is cross-posted from Marc to Market with permission.