By Christian Hawkesby*
As New Zealand focuses on the general election this weekend, there is another political event that has the potential to create much wider disruption to global markets. The Scottish people vote on independence from the United Kingdom on Thursday.
As New Zealand markets open on Friday, a ‘Yes’ vote has the potential to create significant short-term volatility in forex (FX), equity, credit, and funding markets.
Latest polls suggest that the ‘Yes’ campaign is just behind in the polls, creating the real chance of an upset result that ends the United Kingdom’s 300 years of political union.
The most contentious issue for markets is the currency arrangement for Scotland if they were to become independent. All major political parties in Westminster have ruled out a currency union with the rump of the United Kingdom. Bank of England Governor Mark Carney put it succinctly when he said "A currency union is incompatible with sovereignty”.
The ‘Yes’ campaign has labelled this scare mongering, but has failed to outline an alternative arrangement. Put simply, it is unclear what currency will be used in an independent Scotland.
There are four main channels that a ‘Yes’ win could impact financial markets.
- Foreign exchange markets: With heightened uncertainty, the Great British Pound (GBP) has already weakened against the NZ dollar since the ‘Yes’ campaign rose in the polls. GBP would be the first source of volatility on any Scottish news.
- Funding markets: A ‘Yes’ vote could spark a run on Scottish based banks, as depositors seek to resolve uncertainty by relocating their funds south of the border. This has scope to temporarily disrupt the global interbank funding markets, including for Australasian banks.
- Equity and credit markets: With global equity and credit markets near all-time highs, they are potentially vulnerable to a spike in volatility following a ‘Yes’ vote.
- Europe: Over a longer period, a ‘Yes’ vote could disrupt Europe, by raising the hopes for independence in regions like Catalonia and the Basque Country.
If the ‘Yes’ campaign is successful, March 2016 is the planned date of Scottish Independence. Until this time, it will still be the responsibility of the UK authorities to manage the transition as smoothly as possible.
So we expect that the UK government and Bank of England would quickly announce a package of measures to calm markets and depositors, including ample liquidity support to banks north of the border, and fast track arrangements to allow those banks to relocate their legal headquarters south of the border.
So while a surprise win by the ‘Yes’ campaign may trigger an immediate flight to safety and spike in global market volatility, a successful package of transition measures could make this a more manageable wobble for markets.
*Christian Hawkesby is director and head of fixed interest & economics at Harbour Asset Management.