The Aftermath of Scottish Referendum

The dust is settled in the Scottish referendum with 55% voted “No” to independence while 45% voted “Yes”. Yet, the story does not end here. Westminster has made promises of further devolution for Scotland with new powers over tax, spending and welfare to be agreed by November, and draft legislation published by January. There would be considerable changes in constitutions and thus the “no” vote is not equivalent to “no change” in the UK. The focus now is returned to the economic and monetary outlook. We expect to see a mixed picture in GBPUSD whilst EURGBP would meet further selling pressure.

While the referendum result has prevented Scotland from breaking away from the UK, the 45% vote to independence and the Westminster’s promise to further devolution should have pronounced implications to UK’s political environment and the economic outlook. It is possible that “further devolution for Scotland” would lead to demand for further devolution for Wales and Northern Ireland and eventually general discussions of a more ‘federal’ UK. Indeed, David Cameron indicated earlier today that “it is absolutely right that a new and fair settlement for Scotland should be accompanied by a new and fair settlement that applies to all parts of our United Kingdom”. The devolution measures would then affect the political interchange in the upcoming UK general election in 2015. As uncertainties remain after the referendum, foreign investment in the UK might be dampened for some time amidst diminished investors’ confidence in the near-term.

At the time of writing, GBPUSD has retreated after soaring to a 2-week high of 1.653 as most of the risk premium that had been built into the pound had unwound before the referendum. Indeed, the fundamentals and BOE’s rate hike expectations may not support the currency pair to climb higher. The selloff in the pound to the lowest level since last November, as well as an outflow of $672m from UK equity fund, in the past week with opinion polls showing the” yes” and “no” had narrowed, suggested that what investors are concerned the most is uncertainty. The uncertainty might not dissipate entirely in the aftermath of the referendum. This might continue dampen capital inflow, a GDP-supportive factor over the past year, in coming months.

In the medium-term, currency movements would be mainly affected by central bank outlooks. The wrestling between GBP and USD would depend on the rate hike schedules of the Fed and the BOE. Meanwhile, the ECB is looking to ease further with President Draghi announcing ABS and covered bond earlier this month. He also indicated that there are “significant and increasing differences in the monetary policy cycle between major advanced economies”. The ECB is getting more dovish whilst the BOE is expected to begin tightening early next year. The yield differential should lead EUR to weaken against GBP.

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