Pound Smashed by Scottish Independence Vote Uncertainty: GBP to EUR Down 0.7 pct, GBP/USD Down 0.54 pct

Why are British pound (GBP) exchange rate conversions continuing to fall on the global currency markets at the present time?

The answer lies with political risk and uncertainty - something currency markets are incredibly sensitive to.

Sterling has taken a tumble this week despite the release of better-than-expected construction and services PMI data; usually such a beat on expectations would see the currency bid higher.

The Race Tightens in Scotland

The latest YouGov poll on voting intentions in the upcoming referendum has revealed that the gap between the No and the Yes vote has narrowed markedly.

The No vote still leads at 53% to 47% for the Yes vote, but that represents a narrowing of 8 points from the 14 point lead just a month ago.

"The sudden surge in the Yes vote has clearly unnerved the markets and selling in cable accelerated as the morning wore on with the pair trading to a low of 1.6520. Currency markets are notoriously sensitive to political risk and if the polling suggests that the Yes vote is approaching the margin of error then cable could see a further sell off through the key 1.6500 support level," says Schlossberg.

We had been forecasting a positive September for the pound, however we had also warned that the main risk in the near-term concerns the Scottish independence vote.

At the time of writing (04/09) currency markets are seen extending their GBP sell-off: 

• The pound to dollar exchange rate (Cable) is seen to convert at 1.6335. Consider that the high reached yesterday was 1.6615.
• The pound to euro exchange rate (GBP/EUR) is at 1.2626. The previous day's high was at 1.2654 showing just how far the sterling euro has fallen.

Potential Market Outcomes

Forecasting how financial markets, and the pound sterling in particular, will move before and after the referendum is particularly difficult to call.

Nevertheless, Kathleen Brooks at Forex.com discusses a few potential outcomes:

GBP falls in the short term after a yes vote, as markets ponder what this means for the UK; however in the long term GBP rallies as some think that the Britain without Scotland will lead to more Conservative governments getting elected in future, which tends to be currency positive as the Conservatives have better economic reputations.

GBP falls in the short and long term if the UK has to cover Scotland’s portion of UK debt, this could also impact Gilts, and could make it more expensive for the UK to borrow, which would likely be pound negative.

UK stocks may fall on a yes vote, although we think any weakness will be short lived because Scotland is such a small part of the UK economy.

But, if the international community thinks that a yes vote for Scotland makes it more likely that the UK will leave the EU this could be universally bad for UK-based assets.

What Can the Canadian Experience Teach Us?

While the UK has never experienced a referendum of this kind before Brooks points out that it is worth remembering that in 1995 Canada held the Quebec referendum, which asked voters whether Quebec should proclaim national sovereignty and become an independent state, much like the Scottish referendum.

Canadian experience as an example, back in 1995:

• In the two weeks leading up to the Quebec vote, USDCAD rallied (CAD fell) more than 3.5%.
• In the few days before the vote USDCAD traded sideways.
• The day after the vote saw a large reaction in the CAD, USDCAD erased previous gains and fell nearly 3%.
• The Canadian stock market sold off sharply in the run-up to the referendum, however, it bounced back on voting day and the day after.

Forecasts: What Will All This Mean for the Pound?

According to Brooks the outlook for GBP/USD is not aided in anyway by the uncertain outlook:

"We mentioned yesterday that the rebound in the pound did not look sustainable, and it hit a wave of headline-inspired selling pressure around 1.6644 earlier today, well ahead of key resistance at 1.6765 – the 38.2% Fib retracement of the July – August decline.

"The resumption of the downside is now in full swing, and we look for a break of key support at 1.6460 – the low from March 24th. Below here opens the way to 1.6284 – the 38.2% Fib retracement of the July 2013 – July 2014 bull trade."