Sterling dips, Treasury acts on Scottish vote concerns

LONDON: Sterling and gilt yields dipped in steady trade on Monday with a move by the UK Treasury to head off any nerves around this year's vote on Scottish independence prompting the first open market talk of the risks involved.

Debate over the pound's prospects at the start of the new year has focused on the strength of Britain's economic recovery and whether markets are right to assume the Bank of England will raise interest rates early next year, well ahead of its peers elsewhere in the developed world.

But creeping over the horizon are risks to the political and constitutional status quo, led by the Scottish vote in mid-September, which may have knock-on effects for 2015 elections and a proposed referendum thereafter on EU membership.

There was no discernible price action on Monday, and little is expected for months to come, but the UK Treasury said concerns expressed by market participants were behind its clarification that it would be liable for all existing gilts until maturity.

"People have begun to talk about the issues around Scotland and clearly that is why the Treasury has issued this statement this morning to try and get ahead of things," said Richard Holt, economist at Capital Economics in London.

Any market nerves over the vote so far have been cooled by opinion polls which show First Minister Alex Salmond's Scottish Nationalist Party are 16-25 points off the majority support they need to win in September.

But investors have also begun to do the due diligence on Salmond's political track record, which shows he turned around a similar deficit to carry the last elections to the Edinburgh parliament in 2010.

A Yes vote would open a huge can of worms including how negotiations with London then divided up debt, oil revenues, resources and two of Britain's biggest banks. The question of whether Scotland would keep sterling, peg to the pound or launch a completely independent currency is also unresolved.

"Banks in Scotland in particular are going to have to think very clearly about the impact on their businesses and the choices they will have to make," said Philip Rush, an economist with Japanese investment bank Nomura in London.

"My suspicion is that businesses would much rather avoid the risks that come with independence."

EU RISKS

Banks and business leaders have so far been coy about taking a stance on the referendum, but London-based economists tend to stress the risks for the Scottish economy rather than the opportunities in locally focused development the SNP says will result.

Of more concern to financial markets, however, is the risk the Scottish referendum will swing Britain further to the right ahead of a plebiscite on EU membership that Prime Minister David Cameron has promised sceptics in his Conservative Party.

Rush, Holt and others argue that to compete in an election fought only in England and Wales, the opposition Labour Party would also have to offer a referendum on entry that opinion polls already show is more than losable.

"Scotland is 8 percent of UK GDP and while that is not to be sneezed at, its not the game changer for Britain that leaving the European Union would be," said Holt.

"There is far more anxiety there."

Sterling in general has had a bullish six months, rising 10 percent against the dollar since last July to trade at $1.6370 on Monday. Against the euro it was off half a percent at 83.86 pence. The jury is out as to whether that will clear the way for a fresh push higher or signals the current run is coming to an end.

"I suspect sterling/dollar direction might be to the downside, particularly if the BoE comes up with any rhetoric that reminds the market how long it is willing to keep interest rates at current levels," said John Hardy, head of FX strategy at Saxo Bank.

Inflation data for December is due on Tuesday.