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Brexit by Another Name
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Andrew Kositkun Senior FX Advisor
Since the start of the year through the end of February, the British pound (GBP) has been fairly impervious to the market’s shift toward U.S. dollar strength. As an illustration, data shows that positioning for a weaker U.S. dollar has been reduced by 67% from its peak. Conversely, positioning for a stronger GBP has only pulled back by 20%. This relative resilience is in large part due to the U.K.’s relative vaccination outperformance. However, recent GBP price action suggests that markets are becoming increasingly concerned about the U.K.’s ability to remain an economic island unaffected by the worsening COVID-19 situation in Europe as well as about the potential for a second Scottish independent referendum.
Scotland held its first referendum to become an independent state on Sept. 18, 2014, when voters chose to stay part of the U.K. by a 55% to 45% margin. While that vote was expected to settle the issue once and for all, the U.K.’s decision to leave the EU against the wishes of the majority of Scottish voters has raised the possibility of a second vote.
While the U.K. government has rejected the possibility of a second referendum, the Scottish National Party (SNP) put forward a bill that sets out the intention to hold a second referendum within the next two to three years, even without consent from the Westminster Parliament.
As to whether this bill will be passed, thus throwing the U.K. into another constitutional upheaval, much depends on the outcome of the Scottish parliamentary elections on May 6. The SNP has slipped in recent polls, so it is a much closer call as to whether the SNP can regain the outright majority it lost in 2016. Failure to secure an outright majority would damage prospects of the bill passing, but it would not guarantee that the U.K. would avoid the possibility of another few years of constitutional angst.
As for the GBP, it is true that the first independence referendum in 2014 didn’t adversely affect the pound until the last month or so before the vote. But this was because opinion polls showed a strong majority against independence for the bulk of the campaign. This time around, opinion polls are different, with recent polls showing an outright majority in the low single digits favoring independence. Granted, polling data got Brexit and the last couple of general elections wrong, but it did get the 2014 Scottish referendum right. Regardless of the polls, it is likely that investors have learned their lessons from the Brexit vote and are unlikely to leave themselves similarly exposed.
In considering the potential impact of a Scottish independence, a good starting point is acknowledging that Scotland accounts for 10% of U.K. GDP, so it would be the equivalent of Texas leaving the U.S. The choice of monetary arrangements will also be important in determining many of the economic and financial consequences of independence. There are three broad options: 1) a formal agreed-upon currency union with the rest of the U.K.; 2) informal use of the GBP; or 3) the introduction of its own currency. Option one would be least disruptive, although it would likely be ruled out by the U.K. Options two and three are likely to increase uncertainty due to questions on the sustainability and credibility of the new monetary regime.
Scottish independence would also impact the pound through its effects on the economic structure of the U.K. A key factor here is the exclusion of Scottish oil exports from the U.K.’s already negative current account balance. Finally, there are the political consequences. Back in 2014, the exclusion of Scotland’s left-leaning parliamentary members would have made the Westminster Parliament more euroskeptic. But with the U.K. already out of the EU, the political consequences are now more benign.
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