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    Is GBP turbulence to be expected with a possible IndyRef2 on the horizon?

    6 May 2021

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    With Scottish parliamentary elections well underway, the possibility of a new independence referendum is on everyone's mind. If the incumbent Scottish National Party (SNP) were to walk away with a decisive victory, could another popular vote soon be on the cards? And what impact would this have on the pound sterling (GBP)?

     

    According to exit polls shortly before voters took to the ballot boxes, today’s Scottish parliamentary elections may result in a victory for pro-independence parties. Should this scenario play out, as anticipated, fears about the future of the UK and its post-Brexit territorial integrity may yet be reignited.

    The prospect that Scotland could one day secede from the United Kingdom and join the European Union (EU) as an independent country is no longer out of the realms of possibility. In June 2016, 62% of the Scottish people voted to keep the UK in the EU.

    For the time being, the spectre of another Scottish independence referendum has had limited impact on the pound sterling (GBP) exchange rate. But there is now good reason to believe that the British currency will experience a more turbulent post-Brexit period than many had foreseen.

     

    Three steps towards possible Scottish independence:

    • Pro-independence parties must win the 6 May elections.
      This is very probable. Voting takes place today from 7:00 until 20:00 local time (GMT). The official results are not expected until tomorrow morning, Friday 7 May.

    • The UK Parliament must agree to Scotland’s request for a new referendum (as was the case in 2014).
      This is also a possibility, though it could raise strong opposition within the ruling Conservative Party in Westminster.

    • Scottish pro-independence parties must win a potential referendum on the issue.
      This last aspect is far from certain, as polls on this subject are particularly volatile. In September 2014, during the first referendum, pro-independence campaigners suffered a heavy defeat (55.3% in favour of remaining in the United Kingdom, versus 44.7% in favour of independence), despite rather favourable polls before the vote.
     

    How do Scottish elections work?

    Elections in Scotland are based on a hybrid system combining both constituency and regional voting. This Thursday, 73 MSPs will be elected in their constituencies according to a first-past-the-post system (the candidate who wins the most votes wins the election). In addition, 56 additional seats for MSPs will be allocated by means of proportional representation at the regional level. This hybrid and complex system makes opinion polls less reliable than in other systems, such as the French two-round majority system.

    Based on the last five polls published, the main pro-independence party, the incumbent Scottish National Party (SNP), is expected to be the big winner. It could win as much as 49% of the vote at constituency level and 39% of the vote at regional level. In the last election, in 2016, the Scottish National Party won a total of 63 seats (65 seats are needed for a majority). In addition, thanks to the six seats won by the pro-independence Scottish Greens, Scotland has been governed by a pro-independence majority over the last few years. A similar scenario is likely to play out in the 6 May elections.

    Although the SNP has lost some of its appeal to voters in recent weeks, due to a number of scandals tarnishing the reputation of its two most recent leaders, current First Minister Nicola Sturgeon and her predecessor Alex Salmond, it can likely rely on the Scottish Greens once again, as well as Alba (the new party founded by Alex Salmond), to secure a majority in the Scottish Parliament.

     

    The ball is in London’s court

    If the pro-independence parties win a majority in the Scottish Parliament and call for a new referendum on independence, as they have pledged during the election campaign, UK Prime Minister Boris Johnson will be faced with a difficult choice.

    He will have two options:

    1. Accept a new referendum and hope that the results remain similar to those in 2014.

    2. Block Scotland’s request, with the help of an 80-seat majority in the Westminster Parliament, potentially opening the door to an interminable legal to and fro between London and Edinburgh.

    Given the fallout from UK Prime Minister David Cameron’s decision to accept a referendum on EU membership, it is likely that the current Prime Minister will favour the second option.

     

    What are the implications for the pound sterling (GBP)?

    For the time being, the risk of another Scottish referendum has not really been factored into market prices. Sterling has lost a little bit of ground against the euro in recent weeks, but this has more to do with the rise in the single currency (linked to increased risk appetite) than with concerns over the Scottish vote. In the short term, trends for the EUR/GBP pair are not expected to change a great deal.

    The rise should continue towards 0.88 (the same level as early February 2021). However, if the spectre of another referendum were to materialise – which is likely in the medium term – sharp increase in GBP exchange rate volatility can be expected, along with further GBP depreciation, against the euro, among others.

    Forex traders will no doubt bear in mind the recent experience of the Brexit referendum, which resulted in sharp GBP depreciation (with the British currency notably reaching a thirty-year low against USD in the immediate aftermath).

    Within this political haze, one thing remains clear from a forex perspective. The possibility of a Scottish referendum is certainly the biggest ongoing political risk to the EUR/GBP pair, and it is anticipated in an unfavourable light by most current market players.

     

     

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