UK, Pound and Scotland

September 3, 2014

It’s not an everyday sight when Scotland has more influence over GBPUSD exchange rate than the actual (important) data out from UK but recently it happened. When the Constrution PMI was released this week, Sterling continued its decline against the USD like nothing happened, even though the data was very good (64 vs 61.5 expected).

The reason why Pound is losing ground is related to the Scottish independence referendum which will take place on the 18th of September and the latest polls are showing that the votes are very close to 50/50. But why it is bad for GBP?

Mostly it is due to a confusion surrounding the use of Pound as an official currency of Scotland. The problem lies in the fact that Scotland has 2 options how to deal with this situation and the 3rd option is to introduce a new currency, together with its own central bank. But let’s focus on the 2 options to use the Pound.

Option nr 1
Scotland keeps Pound as an official currency creating a union with Britain.

It may seem to be easy but actually it is a rather complex situatsion as this is a political decision and currently Britain is not very interested in it. To establish a healthy currency union all sides must operate in a simialr way, meaning that their fiscal policies must be related to make this thing work. But this may not suit to Scotland as most likey they would have to give up a sizeable portion of their independence on goverment spendings + numerous other things. So, it raises a question: why to declare independence in the first place if the very next thing you do, is give it away again.

Option nr 2
Scotland keeps Pound as an official currency but without British goverment’s consent.
That would be extremely unfavorable to Scotland as they would operate with a currency that is controlled by another country and by another central bank, which does not take into account their economical situation. For example, Britain’s economy starts to slow down and BOE decides to launch a QE program but in the same time Scotland is having a real estate boom, so the last thing they would need is excess liquidity.

In conclusion – there are a lot of unanswered questions and uncertainty surrounding Scotlands decisions regarding Pound as an official currency and that is one of the reasons why Pound is losing ground against the USD.

Sources used:

Capital Properties FX