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Forex: Sterling’s Reaction to Scottish Yes or No Vote

I hope for Betfair’s sake that the Scottish Referendum turns out to be a No vote otherwise their early pay out they’ve just made on tomorrow’s vote it going to have been a costly one. It reminds me of one of their competitors that paid out early on Manchester United winning the premiership in the 2011-12 season only to see them slip up in the last stretch and get beaten by Manchester City on goal difference. As mentioned in my last blog on the subject, this vote is going to be very close and there is a distinct chance that the Yes Campaign could pip the No Campaign at the post. This will open a Pandora’s box of negotiation after negotiation on who owns what and how much should be shared between whom. This will cause months and months of uncertainty, something the UK economy can ill afford.

The markets are pricing in a No vote too as sterling has so far this week reasserted itself with GBPUSD recovering to 1.6350, from recent lows around 1.6050 and EURGBP declining back below the 0.8000 level after a brief visit above it. Opinion polls have on average been consistently showing the No Campaign ahead, but sometimes the heart overrules the head and those wavering between yes and no will be conscious that this is their best chance to change the course of Scottish history.

So, how will sterling react in the event of a Yes or No vote? Forecasting FX rates are notoriously difficult however we have put together some thoughts below:

Short-Term and Medium-Term Sterling Forecasts

YES VOTE
FX Rate 1 month 3 months
GBPUSD 1.5500 1.5800
EURGBP 0.8260 0.8040
(GBPEUR) 1.2107 1.2438

A yes vote will cause an immediate sell off in sterling as it has not been fully priced into the market. We saw GBPUSD fall 4 cents following the You Gov poll some ten days ago that showed the Yes Campaign in the lead for the first time ever, a 2.5% fall, but if the vote for independence succeeds then a much bigger sterling sell off can be expected possibly in the region of 5% taking GBPUSD well below the 1.6000 level where it would likely stay and fail to recoup over the medium, even longer term, as the dollar continues to recover.

Against the euro sterling could suffer less of a dramatic fall due to the ECB’s continued loosening of monetary policy and should recoup losses into the year end as central bank policy reaffirms the divergence between the BOE and ECB, even if rate hike expectations from the BOE are pushed back as a result of the yes vote.

NO VOTE

FX Rate 1 month 3 months
GBPUSD 1.6600 1.6000
EURGBP 0.7710 0.7940
(GBPEUR) 1.2970 1.2594

This result would be a boon for the British pound which should see a strong relief rally in the short term as all the worries over how assets and liabilities will be split are swept firmly under the carpet. I say “swept” because the issue is highly likely to resurface at some point in the future, especially if the Scottish National Party maintains its grip on power in Holyrood.

Sterling’s strength however may not last all that long as the existing trend re-establishes itself. The dollar recovery looks to be becoming entrenched and so any bounce in GBPUSD could be largely eradicated come year end.

The one thing that we can expect for sure is that with such a close race volatility overnight on Thursday and throughout Friday is going to be high. My personal opinion is that the No Campaign will win on the day – it’s one thing saying you’ll vote for independence, it’s another when you are standing in the polling booth and actually casting your vote, when often a voter reflects on the significance of such a decision and is more likely to stick with the status quo.

I wouldn’t bet my life on it, but I’ll eat my tartan trews if Scotland parts from the UK.

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