Why Scottish Independence could be an economic disaster
City Index September 16, 2014 5:38 PM
<p>As someone with no Scottish roots, I fully acknowledge that I’m in no position to comment on the emotive elements of a yes vote, which […]</p>
As someone with no Scottish roots, I fully acknowledge that I’m in no position to comment on the emotive elements of a yes vote, which understandably holds huge sway. However, borders have become more artificial today than they ever have been with the power of the internet, the EU and the globalisation of economics.
A ‘yes’ vote in Thursday’s referendum for an independent Scotland within the next 18 months would be a huge economic own goal and, considering the economic backdrop the UK finds itself in, it could also be construed as gross negligence from those championing the yes vote.
The global economy has learnt some tough lessons over the past six years since the global financial crisis and, today, the UK economy is one of the strongest G7 economies. But there remains a long road left to travel down in the recovery and specifically in terms of wage growth.
UK average earnings over a three-month period are at their lowest levels since 2009 (see below chart), whilst the Bank of England and US Federal Reserve (ECB doing the opposite) are both actively looking to hike rates in the near to medium turn.
This means the next phase of the economic growth story will be all about individual earnings. The last thing an individual needs in Scotland (at least earnings-wise) is financial instability and uncertainty, which could have a significant knock-on effect on credit worthiness and, as such, debt, borrowing costs, public spending, employment, inflation and, ultimately, taxes and quality of life. This is not scaremongering. Ask Portugal, Spain or Greece – would they break away from a strong union with the UK if they were in Scotland’s position right now? No way.
Of course, the north vs south divide is omnipresent in any economic dialogue within the UK. London and, to a lesser degree, Edinburgh, is in a far better shape economically than, say, Montrose or Forfar. But that doesn’t mean those in Montrose or Forfar shouldn’t be equally concerned at the economic shockwave that could ensue throughout the country following a yes vote.
There remain so many unanswered questions around the impact a yes vote could have:
What will the Scottish currency be, given the Bank of England would refrain from a sterling union?
How will Scotland afford to defend itself and how will its army, navy and air defence be created or maintained?
How will it maintain an NHS or its pension requirements?
How will Scotland seek to join an EU content with its mere 28 members for the next five years, according to President Jean-Claude Juncker, or will he see Scotland as a special case?
What will happen to the UK’s nuclear Trident arsenal based in Fastlane naval base?
Too many questions and not enough answers breeds uncertainty and nervousness in the markets, hence the weaker pound.
Chart of UK average three-month earnings
A yes vote could create a ‘lame duck’ parliament, threatening GBP
And let’s not forget, Labour have the most to lose from an independent Scotland. There are currently 59 Scottish MPs in Westminster, where Labour holds 41 of them. There remains huge ambiguity as to what will happen to these 59 MP’s should a yes vote proceed. Would they serve for a mere 12 months following May’s UK general election and subsequently be expelled from the UK following the perceived Scottish parliamentary elections in May 2016? Or before then on 24 March 2016 for Scottish Independence day?
The point here is actually the impact this could have on the political landscape within the UK and the strength of government to make the changes it wants and, of course, market confidence.
Even if Labour does manage to win the general election in May, with a majority or minority government, depending on the electoral maths, we could see a snap election called via a vote of no confidence by the Conservatives if they see that Labour minus its 41 Scottish MP’s (from May 2016) gives it a chance to regain power.
We should not discount the fact the electoral process could also change to account for the reduced amount of constituencies in 2016. All of this will result in one thing. Reduced market confidence and a potential lame duck government for a period of 10 to 12 months. Ratings agencies could put the UK on watch for a downgrade, threatening the economic recovery and the pound strength.
GBP volatility here to stay
All you need to do is take a look at the pound sterling or one-week GBP volatility (see below chart) to show how touchy the market is in anticipation of the vote. One-week GBP volatility is now at its highest levels since March 2009, when the bottom in equity markets was found following the financial crisis.
Chart of one-week GBP volatility
A month or so ago the market was convinced this vote would be a bit of a damp squib. Today most polls show the yes and no camps are neck and neck, disturbing relatively calm FX waters in terms of volatility. This has in truth been a speculators dream, of course, as increased GBP volatility has created some good price swings.
How could GBP trade on Thursday/Friday?
I still expect the no camp to win out but certainly there will likely be volatile swings in GBP/USD and GBP/EUR pairs. There remain buyers above $1.60 and €1.2440 as important psychological levels to maintain.
If exit polls indicate a looming victory for the no camp, I expect there could be a relief rally early on Thursday for the GBP as investors breathe a sigh of relief and a degree of tension is removed from the market.
However, a confluence here is likely to be the strength of the US dollar and risk appetite given the FOMC happens 12 hours before voters hit the polls. Depending on how hawkish or dovish Fed Chairwoman Yellen is, dollar strength or weakness will dictate how GBP/USD trades at least until Thursday afternoon.