Uncertainties cloud outlook for UK economy and pound
Britain could become an economic backwater with a doomed currency if Scotland wins independence and the country leaves the EU
Financial markets have a deep aversion to uncertainty. In the coming months, the British economy and the pound will be sucked into a vortex of the unknown. It is not just a possible shock from Scotland's independence vote on September 18 that is weighing on the pound. There is a much bigger risk for British markets.
Next year's general election could mark a High Noon for Britain's future in the European Union. The stakes are high and the threat to the country's economic prosperity is considerable. The pound stands at a crossroads. And it is no surprise global markets are starting to give the pound a wider berth.
Thanks to growing market worries, the pound has sunk to a seven-month low, losing 6 per cent two months after hitting the peak of a six-year cyclical rally in early July. It is likely to feel more pain in the short term - and over the long term, too.
The Scottish independence vote will be cathartic for Britain's currency perceptions. There is so much at stake - not just for the pound, but for the British economy and its political future. At this stage, Scotland's referendum vote is too close to call. Last-minute polls suggest only a 2 per cent swing to the Yes camp would be enough to win independence for Scotland.
The only positive outcome for the pound would be for Scotland to reject independence
An outright win for independence opens up a Pandora's box of economic, social and political risks ahead. The only positive outcome for the pound would be for Scotland to reject independence. A short-term relief rally would probably follow, but the damage has already been done.
Whatever next week's outcome, Scottish independence is already a done deal at some stage. The momentum for change and self-determination in Scotland has been so great in recent weeks that the bandwagon effect is bound to carry over.
The economic consequences are huge. British gross domestic product would shrink 8 per cent at a stroke. The economy will be deprived of key oil revenues - worth up to £6.5 billion (HK$82.2 billion) in taxes paid to the government last year.
There are no contingency plans for separation. Uncertainties remain over Scotland's currency intentions. Central bank supervisory authority is in serious doubt. There are major question marks over Scotland assuming any share of Britain's national debt. There are serious risks of an exodus of Scotland's financial services sector seeking cross-border refuge in Britain in the event of a split.
Political and economic divorce would be a messy, long-drawn-out affair. Increased uncertainty will have serious consequences for investment, employment and growth prospects for years to come.
The structural shock to Britain's public-sector finances would have grave implications for the country's creditworthiness. The risk of a run on the pound and a sharp sell-off in British government bonds could lead to a damaging rise in interest rates and higher long-term yields.
Raising British interest rates from zero back towards a 3 to 4 per cent target in the next two years would help stabilise the pound. More importantly, the Bank of England needs to keep a steady hand on the tiller in uncertain times.
There is much more deep-rooted danger for Britain further ahead - the risk of the country voting to leave the EU at some stage over the future. This will come to a head at next year's general election, due to be held by May 7.
Recent polls show the majority of British public opinion supporting an exit. It could be a self-fulfilling prospect. British Prime Minister David Cameron has already pledged to hold a referendum on the EU by 2017, if re-elected next year.
If Britain leaves the EU, the consequences would be cataclysmic. The economy could be ruined beyond repair. Trade would be jeopardised since the EU is Britain's biggest trading partner. Major foreign companies would desert Britain's shores for Europe. Output and employment would collapse - depression could be on the cards.
Britain without Scotland and marginalised outside Europe would become an economic backwater. There would be a very serious run on the pound. The odds of the pound testing parity against the US dollar would be very high. The pound would be a doomed currency.
