News Column

Nils Pratley: Analysis The City wakes up to 'What if?'

September 4, 2014

Nils Pratley

The City has had to wake up. For the past year, economists, investors and financial strategists have barely bothered to think what Scottish independence would mean. The view has been: what's the point of worrying about something that the polls say won't happen?

That complacency has been exploded by the opinion poll that showed the no campaign with a lead of just 53% to 47%. Suddenly the question is: what if it does happen?

"The near-term fallout could be serious," says Rob Wood, chief UK economist at Berenberg bank. "The biggest initial issue would be a spike in uncertainty. Firms could delay investment and consumers could shun big-ticket spending until the post-independent arrangements became clear. That could cause a setback for the Scottish economy and a hit to the 'rump' UK."

That worry appears already to be affecting sterling, which hit a seven-month low against the dollar yesterday at $1.6442. At the very least, a vote for independence would probably delay a rise in interest rates, which the City currently expects next February.

Amid the unresolved question of an independent Scotland's long-term currency arrangements, some economists say the Bank of England's first priority might be to ensure that Scottish banks do not suffer a rush of withdrawals.

Thinktank Capital Economics says: "We would not be surprised if the Bank of England's contingency preparations included capital controls on the Scottish financial sector to prevent a run on Scottish banks immediately after the referendum result was announced."

Bankers themselves, however, wonder how such a policy could be implemented in practice: their systems are not designed to disallow transfers between Scottish and English branches.

UK debt - in theory - would be viewed by financial markets as a riskier bet since there is a remote possibility that an independent Scotland would refuse to take its share, estimated to be about pounds 120bn. The effect of a smaller UK carrying the same debt burden would be to push up debt-to-GDP ratios, currently about 75%, by about seven points. In practice, however, markets might take that event in their stride. The Treasury has already affirmed its commitment to service all gilts in all circumstances; the possibility of interest rates being lower for longer might push gilt yields lower.

Instead, it is the currency question that now obsesses the City. Kevin Daly, senior economist at Goldman Sachs, said yesterday: "The most important specific risk, in our view, is that the uncertainty over whether an independent Scotland would be able to retain sterling as its currency could result in an EMU-style currency crisis occurring within the UK."

It is the credibility of Westminster's hardball threats on a currency union that markets would almost certainly want to test. Markets can force events and a mini-sterling crisis might be the quickest way to resolve uncertainties.

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Source: Guardian (UK)

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