Could a New Scottish Currency be Stronger Than the Sterling?

In a note to clients Deutsche Bank touch on currency valuations and a range of other scenarios that exist surrounding the currency question.

The stakes can't be higher; "never in history has there been a monetary union breakup in a unitary state with such a modern and complex financial sector," says Oliver Harvey at Deutsche Bank.

Harvey has said both the UK and Scottish governments should be hard at work planning for the possibility of a UK breakup owing to the complexities posed by the currency question.

Here are the key currency considerations facing an independent Scotland and the remaining UK according to Deutsche Bank:

• The UK government have dismissed a currency union with an independent Scotland, but it would in practice be impossible to unilaterally sever the Scottish banking system from the rest of the UK without major risks to financial stability.
• At the same time, Scotland could not ‘share’ sterling in the absence of central bank financing. ‘Sterlingization’ would carry very substantial risks for Scottish growth.
• A currency union is one option the governments of an independent Scotland and the rest of the United Kingdom (RUK) could take. However, this would not be without its own set of risks, in particular Scotland’s exposure to oil prices. A full fiscal and banking union would be required.
• Creating a new Scottish currency would be complex and risky. An effective and transparent banking settlement would be required. Without one, the Scottish and R-UK governments would risk capital flight and a potential loss of confidence in the banking sector.
• We anticipate any redenomination of contracts would be messy and beset by legal challenges. Scotland would also have design a new payment and clearing system and provide physical currency.
• Above all, for currency separation to be successful, the Scottish and RUK governments would have to work together. Due to the complexity of the task, we recommend contingency plans begin to be drawn up now.

Pound Sterling Down, New Scottish Currency up?

According to Harvey, the impact of a ‘yes’ vote in September would be a negative for GBP, while a unilateral split could cause a sharp sell off.

A new Scottish currency could well appreciate against sterling in the medium term.

If a bilateral breakup occurred, a future Scottish currency might initially fall in value against sterling as a result of market perceptions of Scotland as less safe.

"In the medium term, however, the direction of a future Scottish currency is less straightforward. Relative productivity and prices suggest it may even rise in value to sterling," says Harvey.

It is also likely to be highly correlated to oil prices and Deutsche Bank see the loss of Scotland as a mild negative for sterling in the medium term.