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Sterling under pressure as the referendum looms

Thursday’s historic Scottish Referendum is fast approaching with the debate continuing to heat-up from both camps; even Her Majesty has stated that she hopes voters ''think very carefully about the future''.

In the lead up to Thursday’s event, Sterling has been under pressure as market jitters and uncertainty continues to surround the outcome. Since the beginning of September, Sterling has moved as much as 3.6 percent lower against the US Dollar as surveyed polls showed that the gap is narrowing, with some polls showing the vote for independence winning.

The debate is heating-up, with the UK Government set to announce potential new powers to Scotland if the vote to stay within the union is decided. However, Scotland's First Minister, Alex Salmond dismissed the devolution move as a "bribe" from Westminster.

If Scotland votes for independence, its first objective will be to attempt to form a currency union with the UK. Scottish Finance Secretary John Swinney confirmed after the second live debate that Scotland will not pay its share of the UK debt if it does not get a currency union after independence.

However, what is Salmond Plan B’s if a currency union fails.

Option 1
Scotland continues to use the Pound without agreement.
Ex Chancellor Darling admitted Scotland could use sterling without the UK's permission. However, if Scotland pursues this route it would leave them particularly reliant on how the UK economy performs. Scotland’s economic performance would have no bearing on the currency thus leaving its importers and exporters exposed to outside forces. In addition, Scotland would also have no control on interest rates. More importantly the BoE would not act as a lender of last resort to Scotland’s financial services sector, therefore they would be unprotected if we were to see another economic disaster.

Option 2
Scotland could form its own currency.
This in itself could work in a number of different ways. For instance, a new currency could be kept at a fixed rate to Sterling (pegged), or it could be left to float of its own accord. This will be an expensive operation and not favoured due to high set up costs. It would mean the introduction of new institutions such as a central bank, new notes and coins would need to be issued and circulated and the old notes and coins withdrawn. In addition, there will be legal ramifications and costs, however it would give Scotland more flexibility.

Option 3
Scotland could join the Euro.
Scotland could apply to join the European Monetary Union (EMU) and then use the Euro which would mean the ECB would control interest and exchange rates. There would be several rerequisites and economic requirements that would need to be met before joining the EMU. However it is really hard to determine whether these will be put into place due to the way that figures are reported (UK based) and what ramifications defaulting on UK debt would have. The currency issue has been one of the main topics for discussion during the live debates. It has also been stated, by investment bank Morgan Stanley, that Sterling could fall as much as 10% if Scotland votes “Yes” for independence. As we approach the crucial referendum on 18th September 2014, opinion polls will be closely watched by the markets as the gap between the “Better together” and the “Yes” vote is narrowing. The end result could come down to the swing of the undecided voters. For both UK importers and exporters this event carries considerable risk. Both should look at hedging instruments to protect themselves from this unprecedented and historic event. There are still too many questions to answer on both sides of the vote which could result in adverse volatility.