In the wake of the 2016 vote for Brexit, many questions regarding the future of the United Kingdom (U.K.) have come to the forefront. A fluid political and economic situation has ensued, causing existing members of the European Union (E.U.) and U.K. to reevaluate ongoing relationships. The Scottish Parliament has done just that, voting in favour of an independence referendum, which is the second since 2014.
While a definitive schedule for the Scottish independence referendum has yet to be finalised (as of January 2018), it is expected to coincide with the U.K.'s timeline for leaving the E.U. The authority to actually call the vote lies with the First Minister of Scotland, Nicola Sturgeon, and the U.K. government. Action from Sturgeon is not expected until the U.K. reaches a formal deal to exit the E.U., which is projected to take place in October 2018. An absolute timeline for the vote remains vague, with the Scottish National Party (SNP) having a valid mandate until the next election cycle slated for 2021.
A vote of "yes" for Scottish independence may have severe consequences for the British pound sterling (GBP). Aside from enhanced pricing volatilities surrounding the vote itself, the GBP is likely to face prolonged scrutiny from currency traders and investors. A similar reaction to that of Brexit is possible. Actions taken by the Bank of England (BOE), coupled with uncertainty in the marketplace, are probable catalysts for the GBP to be repriced against other major global currencies.
The U.K./Scotland Economic Relationship
Independence has long been a hot button issue for the nations that comprise the U.K. Dating back to the early 18th century and the formation of Great Britain, as well as the 1921 addition of Northern Ireland, periodic threats of secession have been prevalent.
The official U.K. role includes four member countries: England, Scotland, Wales and Northern Ireland. Along with England and Wales, Scotland serves as a member of both Great Britain and the U.K. Scotland's geographic location and its population of more than five million ensure that it is an integral part of the U.K.'s political and economic structure.
Economically, Scotland is a valuable trade partner for other member nations of the U.K. Scotland's U.K. exports are valued at nearly £50 billion per year, representing 63% of its total trade. In comparison, exports to the countries of the E.U. account for 16% of aggregate trade, valued at £12.3 billion annually.
The following are Scotland's leading exports to the U.K.:
|Export||Annual Value||Percent of Exports|
|Food and Drink||£4.8 billion||16.8%|
|Scientific and Technical||£3.5 billion||12.2%|
|Wholesale Products||£1.6 billion||5.7%|
Perhaps the most critical economic alliance between members of the U.K. and Scotland is the manufacture and trade of petroleum products. The oilfields of the North Sea are a primary hub of economic activity. Although energy markets are cyclical, the North Sea oil fields are a constant source of employment, tax revenue and industrial output. North Sea oil employs between 300,000 and 500,000 workers, generating £57 billion per year in U.K. tax revenue.
Scottish independence has the potential to change the infrastructure facing North Sea oil. Scotland is a key player in the drilling and transport of energy products to the rest of the U.K. Access to shipping depots and the Forties pipeline system, which transports product from 85 platforms to the mainland, may be restricted if Scotland seceded. A re-negotiation of existing terms between energy transport companies and the new governmental structure may dramatically reshape the North Sea oil and gas industry.
In the event that an independence referendum passed, the U.K.'s economy as a whole would undergo a fundamental change. Consequences include new trade deals, loss of tax revenues and a restructuring of the energy industry. The GBP may be considerably weakened as the U.K.'s future prospects of economic growth and industrial output will be brought into question.
Scottish Independence And The GBP
As the official currency of the U.K., the British pound sterling exhibits a sensitivity to political events that bring uncertainty to the marketplace. Like Brexit, a vote of "yes" for an independent Scotland has the potential to shake confidence in the currency.
In the immediate aftermath of the Brexit vote, the GBP fell more than 10% against the U.S. dollar (USD), testing levels not seen since the mid-1980s. One year after the U.K.'s vote for Brexit, the GBP remained depressed, down more than 16% against the USD from pre-Brexit levels. While the U.K.'s leading equities indices posted considerable rebounds over the same period, investors remained sceptical about the economic future of a fully autonomous U.K.
The latest movement for Scottish independence is not the first time in recent memory that the idea has come to the forefront. On 18 September 2014, a referendum for Scottish independence was voted down by a margin of 55% to 45%. Concerns over Scotland's eventual acceptance into the E.U., as well as increased power commitments from the U.K. to the Scottish Parliament, were driving factors behind the outcome.
In the run-up to the 2014 vote, polling data had a considerable influence on the GBP. Upon the release of a YouGov poll that showed growing support for a "yes" outcome, the GBP rapidly fell 0.5% against both the USD and euro (EUR). As the results of the referendum vote became known, currency investors were receptive to Scotland's decision to remain a part of the U.K. In subsequent trading, the GBP hit a two-year high against the EUR and rallied 0.8% vs the USD.
The 2016 Brexit vote and the 2014 Scottish referendum both served to undermine the GBP.
Ahead of the 2014 referendum, analysts estimated that a "yes" vote was to drop the value of the GBP by 10%. Even though the result of the referendum was a resounding "no," polling data releases before the vote illustrated the relative sensitivity of the GBP to the idea of Scottish independence.
As Scottish citizens take to the polls and address the new independence referendum, the GBP is highly likely to exhibit similar behaviour. Volatility will be on display before, during and after the vote, with the prospect of a "yes" outcome serving to weaken the GBP.
As a general rule, markets are not fond of uncertainty. Dissolving the existing incarnation of the U.K., an arrangement that has stood for nearly 100 years, will create many questions directly impacting the British pound:
- Will Scotland retain the GBP as its official currency?
- Will Scotland seek and gain acceptance into the E.U.?
- How will the U.K.'s access to North Sea oil/gas be affected?
- How will the U.K. deal with the loss of Scottish tax revenue?
- What will be the future of the Scotland/U.K. trade relationship?
These questions are the tip of the iceberg but represent several concerns facing the U.K. The economic impacts of Scotland joining the E.U. are extensive. A Scottish adoption of the euro and restriction of the energy supply to the U.K. can greatly impact the British economy. While the transition to an independent Scotland will certainly be gradual, the GBP will face many challenges as the process runs its course.
If the fallout from Brexit is any indication, a vote for Scottish independence will throw forex valuations facing the GBP into chaos. It is difficult to determine the long-term ramifications, but the immediate impacts will be enhanced volatility and investor scepticism. The future status of the GBP as a major global currency will depend greatly upon how the U.K. adapts to the new economic and social environment.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…